Deferred Payments When Selling a Company

When selling a private company it is very common that part of the payment received by the seller will be on a deferred basis. This article discusses the best ways to deal with this common type of transaction structure.

Deferred payment has always been part of the market for private company sales. Since the events of 2009 it has become a more important part of payment terms.
 
Why Have Deferred Payments Become More Common?
 
If you have tried to borrow money from a bank in the last few years you can be only too aware that the supply of credit is greatly diminished. This has had an inevitable impact on the market for buying and selling companies. Deferred payment, or put more plainly payment of some of the selling price from the future profits of the company, has become a larger part of the selling price.

The trend to a larger deferred component is not only about the credit squeeze. Buyers in general are more nervous about the economy and more fearful that the target company will experience a collapse in sales or profits under their ownership. One way to protect themselves against this happening is to make part of the purchase price payable only if sales and profits hold up. If you put yourself in the buyer’s shoes for a minute it is not difficult to understand these concerns.
 
Should You Ever Accept An Offer With A Deferred Component?
 
Since 2009 banks have to all intents and purposes withdrawn from funding all but the largest private company sale transactions. Debt can still be secured with asset finance specialists against plant, invoices and sometimes stock, but term loans secured against cash flow are a thing of the past. This means that some element of deferred payment is inevitable in almost every private company transaction. For the seller the stark choice is often between accepting a deferred payment component, or keeping the company.

Negotiating a deferred payment structure is always complex and contentious. Both sides understandably tend to get stuck on particular “What if?” scenarios, however unlikely to happen. Nevertheless, with goodwill on both sides, and the necessary safeguards in place, there is no reason to unduly fear a deferred element of payment.
 
What Is The Best Way To Structure Deferred Payments?
 
The trend to a bigger deferred element carries obvious risks for the sellers. Will the buyers keep up the payments?Can the payment calculation be manipulated? What recourse do I have if the buyer does not pay?

We advise clients to take the following steps when setting up a deferred payment plan:

• Keep the length of the payment plan short – certainly no more than two years, better still one year or less;
• Base the payments on the simplest possible calculation – for example sale of stock, a commission on sales, or achieving gross margin targets – this makes it difficult to manipulate;
• Try to avoid structures that pay out only when a threshold is passed, and nothing if it is not – structures like this are too easy, and too tempting, to manipulate;
• Make sure your legal adviser negotiates access to enough accounting information to check the calculations – and a right to audit;
• Ask to speak to the buyer’s bank or accountant to get a better understanding of their ability to maintain the payment plan;
• Ask the buyer’s directors for personal guarantees of late payments.

 
What Is The Difference Between An Earn-Out And A Deferred Payment Arrangement?
 
Earn-outs are a special type of deferred payment structure where the seller required to stay with the business for a period of time (usually at least 2 years) in order to achieve ambitious growth projections. If the projections are achieved the seller will receive a much higher payment for the business. We explain earn-outs and how they work in another article in our blog: Selling A Company – Earn-out Arrangements
 

If you are interested in finding out more about these and other issues relating to the sale of a private company one of our business sale experts would be delighted to talk to you in complete confidentiality. Click CONTACT ME to book an initial phone conversation or call us on 01604 432964.

 
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