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What is an Acceptable Range of Deferred Payment in a Business Sale?

By Divestopedia Team
Published: December 28, 2015 | Last updated: March 22, 2024
Key Takeaways

A mid-market business sale is usually comprised of cash and some sort of deferred payment such as a seller’s note or earnout. We asked our readership to share their experience on acceptable levels of deferred payments.

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We posed the following question across our social media sites: “What is a common range of deferred payment as a percentage of enterprise value (i.e. seller’s note or earnout) in the sale of a mid-market business with an enterprise value between $5 – $100 million?”

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We seemed to hit a nerve given how many responses we received. Here are some of the ones we thought our readers would enjoy…

Don Wiggins, President at Heritage Capital Group, Inc. Says:

“These are two distinct issues. First, the seller note. We handle transactions from $5 to $100 million in enterprise value. All of our sales transactions are to strategic buyers or private equity groups, never individuals. In this space, we rarely see pure seller notes to finance the transaction. Occasionally, we do see an earnout that takes the form of a note and payment will be based on performance milestones. But this is really an earnout.

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“The second issue is the case of a true traditional earnout, which is not usually tied to a note. When this occurs, either as a note or traditional earnout, we typically see upfront payments in the 60-75% range of total consideration range. The remainder of the consideration can be received through the earnout. There is usually a limit on what can be earned additionally this way, but sometimes it’s unlimited.”

Tyler Spring, Managing Partner at Roshi Consulting Says:

In general, earnouts and deferred payments are two different tools to ensure performance. Earnouts can be extended terms and a significant percentage of the firm’s enterprise value. Generally used as an incentivized structure for management and the board to meet/exceed forecasts.

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“In contrast, deferred payments are in place as a hold back because the business is more mature, and an investor has ability to swap key players if need be. Range depends on maturity of company, pipeline and backlog, but standard percentages would range between 15-25%.”

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David Romera Martin, Senior Manager at Accuracy – Corporate Finance Advisory Says:

From my point of view, there is no ‘right’ answer to your question. The answer is just that earnouts are a matter to be negotiated between the parties in a transaction.

“I recently was involved in a transaction between two big chemical companies in relation to an asset deal (a chemical plant located in Northern Europe). I led the buy-side due diligence of the target, although I was much more involved than just the financial due diligence, since there was no M&A advisor for neither the sellers nor for the buyers. Therefore, I was even involved in the analysis of the SPA.

“My client’s lawyer prepared a first draft of the document and circulated it. They had included an earnout clause which established that 20% of the price would be paid in two years time from the closing. It was funny to see how my client quickly discarded presenting this clause to the sellers. This was obviously because they had the feeling that they were not in a position to suggest this kind of clause or payment scheme.

“I believe an earnout is a way to cover from some type of breach or non-fulfillment. Therefore, the earnout is a great tool to be used as a guarantee. If you are a buyer facing a transaction and you have a specific concern about something (with an economic implication), then this is a good issue to try to cover with the earnout.

“For example, if the business plan includes a specific project and part of the projected revenues are based on the execution of this project, you could try to link the payment of part of the transaction price to the correct execution of that project (for instance, the investment in a new machine which would allow you to produce new products, an expansion plan into new territories, etc.).

“In the end, the amount of the earnout is not the only issue to be negotiated between the parties, but also the time frame of the payments and how these are linked to actual concerns of the buyer about the transaction.”

What Divestopedia Says:

Ideally, all deals would be completed in cash, but that type of Utopian world does not exist in the M&A world. The reality is that both buyers and sellers face transaction risks that they are trying to mitigate (and transfer to each other) at all times. This is where deferred payments come into play. As a seller, you need to remember that the only form of consideration that carries no risk is cash. Any other instrument that pays you out in the future, or has some form of contingency attached to it, carries risk that you should consider and manage.

If you are looking at a seller note, then you should consider the interest rate (remember, this note is likely to be unsecured) and the repayment terms. If you are considering an earnout, you need to consider if you can actually achieve the milestones and what type of support (i.e. capital expenditures) you will need from the buyer. These considerations need to be written into the earnout language to make sure you are protected.

We would love to hear what you have to say. Leave us a comment below with what you think is an acceptable range of deferred payment in a business sale.

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Written by Divestopedia Team

Divestopedia Team
Divestopedia is a resource for entrepreneurs who want to sell their business for the best price and terms. Whether you are thinking of selling, have started a sales process, or are post-deal, we aim to arm you with the knowledge required to maximize value and limit your downside risk.

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