When selling a business, the topic of deferred payments and earnouts might not seem immediately exciting. But these mechanisms, often perceived as buyer-friendly, can serve as a tool for sellers to unlock unexpected value while sharing in future success.
Understanding the Real Value of Your Business
Selling a business is all about settling on a price that feels fair to both sides. But here’s the catch: that agreed price doesn’t always mean instant cash in your pocket. Buyers often include deferred payments or earnouts in the deal – this means you might get a portion of the money later, contingent on hitting certain financial milestones.
For example, imagine selling your business for £1 million. The buyer might offer 75% upfront and defer the remaining 25%, payable if the business achieves specific targets in the next year or two.
Deferred payments create a partnership of sorts, allowing the buyer to validate claims about the business’s performance, such as future forecasts. At the same time, these agreements can be structured as incentives, rewarding you if your business outperforms expectations. It’s like a shared bet on the company’s future success.
Spotting the Hidden Upside
Here’s where things get interesting: if you see that upfront 75% as a fair representation of your business’s current value, the remaining 25% can feel like icing on the cake. In fact, some deals go even further, offering payouts that exceed the original sale price if the business thrives post-sale.
These structures can feel like a win-win, aligning the buyer’s and seller’s interests while creating opportunities to share in the company’s future growth.
Staying Involved Post-Sale
Deferred payments often reflect a buyer’s confidence in your business. In some cases, these agreements aren’t just for shareholders – they can extend to key members of the management team. This approach encourages top talent to stay on board and contribute to long-term success, benefiting everyone involved.
When negotiations are rooted in trust, deferred payment arrangements can facilitate a smooth transition. Sellers, buyers, and employees all walk away feeling secure in the deal.
The Risks to Watch Out For
Of course, not every deferred payment or earnout is a golden opportunity. In some cases, the buyer might leverage these mechanisms to shift risks onto the seller. For instance, if your business relies heavily on a single major client, the buyer may delay part of the payment to mitigate their concerns about losing that client.
Whether this works for you depends on your tolerance for risk and the specifics of the deal. Does the deferred portion represent a critical part of your financial expectations? Or is it a welcome bonus you can afford to gamble on? Asking these questions is key.
Pro Tips for Sellers Considering Earnouts
Navigating earnouts and deferred payments requires a careful approach. Here are a few tips to help you avoid common pitfalls:
- Don’t Defer Too Much – Retaining too large a portion of the purchase price in a deferred structure can give the buyer undue leverage.
- Anticipate the Buyer’s Influence – Post-sale decisions made by the buyer could impact your ability to meet performance targets. Ensure these factors are accounted for in the final agreement.
- Get Expert Help – This isn’t a solo mission. Work with business and legal specialists who understand the nuances of earnouts, such as Corporate Finance advisors. They’ll help structure the deal fairly and protect your interests.
Closing the Deal with Confidence
A well-crafted earnout or deferred payment agreement is a testament to mutual trust and a shared vision for success. With expert guidance, you can navigate these complex arrangements and walk away from the deal with confidence.
At its best, your sales agreement will quietly sit in a drawer, untouched – because everything went as planned. At its worst? You’ll be glad you brought the right team to the negotiation table.
If you’d like to find out more about how The MGroup Corporate Finance can support your exit strategy, contact Geoff Pinder: g.pinder@themgroup.co.uk