Wednesday, January 22nd, 2020
With a business purchase or sale, usually the most important term for the parties to agree is the purchase price. Once the headline figure is agreed, it is important that the parties consider how the buyer will satisfy payment. Below, we look at the most common purchase price structures.
Cash payment on completion (no completion account adjustment)
The most straightforward business purchase payment structure is for the buyer to pay a fixed amount on completion of the transaction without any subsequent adjustment.
This method is usually best for a seller as they have certainty as to the amount they will receive, they receive this amount as soon as the business is sold and there are no subsequent downward adjustments (unless they are in breach of any warranties or indemnities provided under the sale contract).
Cash on completion, adjusted in accordance with completion accounts
A completion accounts adjustment is where the agreed headline figure is subject to adjustment by reference to the accounts of the target company as at completion. This allows the parties to ensure the accuracy of the headline figure and gives the buyer the comfort of knowing that the company’s financial position at completion is equal to or better than it was when the headline figure was agreed. Completion accounts can be pegged against any financial target that the parties agree, but the most commonly used is net assets. For example:
Mike agrees to buy XYZ Limited from Paul for £500k, based on XYZ Limited having net assets of £150k. The transaction completes 2 months later on 1st July 2020. Following completion, Paul’s accountant prepares accounts for XYZ Limited as at 1st July 2020, which show XYZ Limited had net assets at completion of £50k. The sale contract provides that, as XYZ Limited was £100k below its target, the purchase price is adjusted downwards by £100k. This is effected by Mike paying Paul £100k.
Sellers should rest assured that the adjustment is normally a two-way street. If, in the above example, the net assets of XYZ Limited at completion were £200k, the sale contract would normally provide that Paul would pay Mike an additional £50k (being the amount by which XYZ Limited exceeded the net asset target).
The seller may agree to the buyer paying the purchase price (or a portion of the purchase price) in instalments. This is riskier for sellers as they are faced with the problem of the buyer not paying instalments on time (or at all). Sellers can alleviate some risk by:
• obtaining security from the buyer. The most common forms of security for deferred payments in a business purchase are:
o a personal guarantee from a director of the buyer;
o a corporate guarantee from a parent company of the buyer; and
o a debenture over the assets of the buyer and/or the target company.
If the deferred consideration element of the transaction is particularly large, a seller may consider asking for multiple forms of security.
• charging default interest on late payments.
• Including provisions for accelerated payment, meaning if the buyer misses a payment, the seller has the right to demand payment of the full amount outstanding.
An earn-out is an arrangement where all or part of the business purchase price is calculated based on the company’s performance following completion. Performance will usually be measured by financial targets (such as profit or turnover) but can be pegged to anything measurable such as a gain in the number of clients or the retention of key employees.
Earn-outs are often used where the parties cannot agree the value of the target company. A buyer may argue that they have agreed to buy the company based on the seller’s projections, so if the company cannot reach the projected targets then the purchase price should rightfully be reduced. A seller should be wary of this. Although the seller’s projections may be calculated in good faith, there are numerous factors outside of their control that could lead to the business not meeting its targets, not least that the seller themselves may have been key to the success of the business.
If an earn-out is agreed, it may be preferable for the seller to stay on with the company in some influential capacity for a period following completion, to assist the company in reaching the earn-out targets.
The buyer may require that the seller keeps all or some of the purchase price in a retention account for a period following completion. This is normally required where the buyer is concerned that the seller may abscond or may not be in a good financial position to meet the costs of any potential warranty claims that the buyer may have following completion. Usually, the retention period is linked to the time period the buyer has to bring a warranty claim against the seller (normally 1-2 years following completion).
It is possible for the buyer to settle all or part of the consideration by non-cash methods. The most common examples are:
• the issue of shares in the buyer to the seller; or
• the issue of loan notes in the buyer to the seller.
These methods are most commonly used where the buyer has insufficient cash or the buyer is a much larger company than the seller, in which case the shares/loan notes may make a good investment for the seller.
If you require advice on a business purchase or sale, please contact one of our Corporate & Commercial Law team on 0207 228 0017 or email@example.com
This article does not constitute legal or other professional advice or a professional opinion of any kind nor does it give rise to a solicitor/client relationship. If you require specific legal advice on the matters contemplated by this article, please contact a member of our Commercial Team.
Alex O’Leary is a solicitor in Hanne & Co’s Corporate & Commercial Law team