I often hear sellers say, “I got X dollars for my company.” Usually there is more to the story, starting with the basic forms of purchase price consideration.
- Cash. This is the most liquid medium of exchange, against which all others are calibrated. However, whether cash was paid for the seller’s stock, partnership interests or assets are important questions that line tax advisers’ pockets.
- Stock. The stock of the purchaser can also be a form of consideration. If the buyer is private, then assurance of going public or an appraisal right is critical. If the buyer is public, the timing of registration rights must be considered. (I chuckle when executives at public companies value their stock higher than where it trades. Never have they suggested that their stock is overpriced.) Many sellers have accepted a buyer’s stock that multiplied in value, while others have suffered from severe declines, so assessing the value of stock and its marketability is a must.
- Notes. Part of the purchase price might be notes from the buyer, the quality of which can vary from investment grade to junk. At one extreme, I have seen notes become worthless when the buyer went bankrupt. At the other, I once sold notes to a bank for face value.
- Escrows. Often a portion of the purchase price will be held back for one to three years; 10 percent of purchase price is typical. Shorter escrows and phased release of funds are better for the seller. (Reps and warranties insurance is an increasingly popular way to replace the need for some escrows.)
- Earnouts. Fast-growing companies often accept an earnout. If the seller achieves its targets, everybody wins. But often, earnouts are a prescription for misunderstandings and lawsuits. The best earnouts are generally for a small portion of the price, short in duration and tied to things easy to measure (sales, rather than earnings). They are attainable without some miracle happening and are not all or nothing.
- Options. Sometimes options in the buyer’s stock are characterized as value. While such options may indeed become valuable, they are speculative and different from cash.
Whatever form of consideration is received, the seller may be saddled with ongoing exposures.
- Continuing employment. Continuing employment can be a burden when the seller wants to retire. Even if sellers are not bound to remain, many feel an obligation to their employees, customers and the buyer. One seller told me, “I cannot walk away; this business is a second family to me, not a sack of potatoes.”
- Representations and warranties. The seller will have to stand behind the reps and warranties in the purchase agreement, often for four to six years. If these don’t hold true, then the seller may have to forfeit the escrow.
As messy as noncash forms of consideration may be, they are often essential to maximize value. That said, every seller must understand that selling a company for multiple forms of consideration is quite different from receiving all cash and walking away clean.
Mark A. Filippell is managing director, M&A Advisory, at Citizens Capital Markets and author of “Mergers & Acquisitions Playbook: Lessons from the Middle-Market Trenches,” published by John Wiley & Sons, Inc. Reach him at [email protected].
