Could ‘deferred consideration’ help you get that deal done?

With funding for acquisitions still being hard to come by, buyers are increasingly looking for ways to spread the cost.

Historically it was the norm for the full amount of consideration to be paid on completion of the deal, but it is now more usual to see a percentage paid up front, with further amounts being paid at a later stage.

The benefits of such arrangements are clear from a buyer’s perspective – it spreads the cost, which assists with cash flow, and may allow you to make a purchase which you otherwise would have passed on. However, for a seller, what incentive is there to agree to let a buyer delay payment? While not ideal, in a depressed economy this may be the only way that you can agree a deal.

There are various methods of structuring such payments, some of which are set out below:

• Cash. In the simplest terms, it can be agreed that some of the money is paid at a later date, for example, six or 12 months after completion.
• Loan notes. Similar to cash, this is where the seller effectively loans the buyer part of the purchase price and receives loan notes in return, which can be cashed in at a later, usually prescribed, date.
• Earn-out. Under an earn-out, an amount is paid on day one, with a further amount being payable dependent on the performance (or other targets) of the business after the sale has gone through. Usually the seller will stay on in the business to ensure or assist performance.

Having agreed to defer some of your payment, there are a few things that you can do as a seller to help ensure that you get your money when it becomes due:

• Escrow. A proportion of the deferred consideration could be held in an escrow account, usually controlled by both sets of solicitors, with the funds being released on the relevant date.
• Guarantee. Sometimes a parent company, or even the buyer’s bank, may be prepared to guarantee the deferred payment in the event of default.
• Charge over assets or shares. This changes your unsecured contractual debt to a secured debt, putting you in a better position than other general unsecured creditors of the business. However be aware that if the buyer has any outstanding secured borrowing (possibly from funding the sale), then you will inevitably rank behind them.

Ultimately, the structure of any deal will depend on the respective bargaining positions of the parties, the desire to sell, and the need to purchase. Professional advice (especially legal and tax) should be taken as to the respective merits of any deal where the seller does not receive all of his money on completion of the sale.

For more information on the legal considerations when buying or selling a business, call David Filmer at Harrison Drury Solicitors on 01772 258321.