A purchase price paid in installments often makes an acquisition feasible. However, this also shifts risks to the period after the closing. After closing, the buyer runs the company, and in principle, the seller has little influence over it and/or insight into the company’s operations.
If you wait until after signing to discuss these risks, it’s too late.
In principle, the purchase price is paid in full (whether or not through (bank) financing) at closing. However, there are also other options, such as:
- using an earn-out; or
- A loan from the seller to the buyer (“vendor loan”).
In an earn-out arrangement, a portion of the purchase price is paid in a lump sum (whether or not through financing), and the remainder is paid after certain predetermined results or goals are achieved; the size of the earn-out may sometimes depend on these results or goals.
The earn-out
Disputes over an earn-out rarely concern the principle itself and almost always revolve around its implementation—particularly the calculation of the earn-out and the way the buyer manages the company. As a seller, what should you pay attention to (among other things)?
- Measurable results: specify what will be measured (e.g., revenue, gross margin, or EBITDA) and how it will be measured. What factors are included? Under what circumstances may adjustments be made to the underlying figures? Including a sample calculation as an appendix to the purchase agreement helps prevent disputes.
- Business operations: Agree that the buyer will continue to operate the business as usual, and specify which actions are not permitted during the earn-out period. Examples include merging companies, shifting revenue or expenses, or passing on unreasonable fees.
- Information and oversight: Make sure you can review and have the interim financial statements audited. It is advisable to agree on a dispute resolution procedure in case of disputes.
What does this mean for the buyer, who views the agreements from a different perspective? Restrictions that are too strict can hinder the integration of the company, reorganization, and investments. Therefore, keep restrictions specific and temporary, explicitly allow room for reasonable business operations, and agree on a maximum term and amount for the earn-out. Also clearly stipulate whether you may offset the earn-out against warranty claims. Uncertainty on this point frequently leads to disputes.
The seller loan
Sometimes the seller finances part of the purchase price themselves. If the buyer also involves a bank for financing, the bank is usually given priority in repayment: the seller’s loan is then “subordinated.” As a result, interest and principal payments are usually made only when the bank permits them. It is often agreed with the bank that interest may be paid even if principal repayment is not yet permitted.
As a seller, it’s important to keep the following points in mind:
- term, repayment schedule, and interest rate;
- The scope of the subordination: Does it apply only to the purchase price financing, or also to other financing by the buyer and its group (“group financing”)?
- When the bank can block repayment payments and what that means for your interest and principal payments;
- whether you’ll receive security, such as a lien (often second in priority), and what you can do if the buyer doesn’t pay.
Ask to review the agreements made between the buyer and the bank. In practice, these determine when you’ll receive your money.
As a buyer, you need to ensure that the loan terms align with the bank financing. Otherwise, you could find yourself caught between the seller and the bank.
What does this mean for you as a buyer or seller?
As a seller, you want to know what portion of the purchase price you’ll actually receive at closing, when and how the remainder of the purchase price will be paid, and what to do if the agreements aren’t met. As a buyer, you simply want to maintain enough flexibility to run your business without too many obstacles.
Therefore, be sure to carefully document the agreements in the purchase agreement in advance. This will prevent ambiguities from leading to costly disputes after the acquisition.
