In acquisition processes, agreements are often made regarding the final payment of the purchase price. Sometimes a portion of the purchase price is converted into a vendor loan (vendor loan), sometimes a portion is made contingent on future performance of the business (earn-out), and many other forms are conceivable.
These solutions can ensure that a deal has a better chance of success, especially if there are differences in valuation between buyer and seller.
While such arrangements are often necessary to get a deal done, they also carry legal risks. Without proper contractual documentation and collateral, these arrangements can lead to conflicts or payment problems - with all the consequences that entails.
In this expert contribution, I discuss the different forms of deferred payments in M&A transactions and provide practical tips to mitigate legal risks.
Forms of deferred payments
Deferred payments come in different forms, depending on the needs of the buyer and seller. The most common forms are:
1. Deferred purchase price
The buyer pays part of the purchase price immediately upon transfer and the remaining amount at a later date or in installments. This arrangement can help buyers better manage their cash flow, but puts the seller at risk of default.
2. Earn-out
An earn-out is an agreement that makes a portion of the purchase price contingent on the business's future performance. This could be based on revenue, profit or other financial goals, for example. While an earn-out is a way to bridge valuation differences, it can also lead to discussions about the calculation of performance and the final amount of the earn-out.
3. Vendor loan (vendor loan).
In a vendor loan, the seller lends part of the purchase price to the buyer. This is often referred to as "converting" part of the purchase price into a loan. This loan must then be repaid to the seller over a period of time to be determined. The advantage is that the seller thereby facilitates the financing of the buyer, which can facilitate the completion of the deal. The disadvantage is that it also exposes the seller to credit risk.
4. Escrow arrangement
An escrow arrangement involves temporarily depositing a portion of the purchase price in an escrow account. This amount is released only when certain conditions are met, such as after the expiration of a warranty period or the achievement of specific performance.
Key points to consider with deferred payments
Whatever form of deferred payment is chosen, it is essential to make proper arrangements and legally secure the risks. Some important points to consider are:
- Lay down clear (payment) terms. In the acquisition contract (the SPA), the deferred payment agreements must be laid down in writing. Within what period must payment be made, under what conditions is the seller entitled to full payment, etc. With an earn-out, it is important to think carefully about how and on what basis the final payment is calculated, and then ensure that it is clearly recorded.
- Provide collateral. One of the most important ways to limit the risk of non-payment is to provide collateral. This could include a bank guarantee, a lien or depositing part of the purchase price in an escrow account.
- Non-payment agreements. If payment is not made (or not on time), it is important that you can fall back on agreements made. Think about agreements on (penalty) interest, immediate claimability, etc.
- Tax implications. A deferred purchase price payment can also have tax implications. It is advisable to check these with a tax professional.
'Take home message'
Deferred payments can smooth an acquisition deal, but they also carry risks. Make sure these risks are properly covered through clear contractual agreements and collateral. Choose the right form of deferred payment that suits the specific deal and provide legal security to avoid problems in the future.
