Maximizing Deal Structure

As the seller, your goal should be to:

• Maximize the cash down you receive
• Maximize the likelihood a buyer can obtain third-party financing
• Minimize the possibility of less favorable forms of payment, such as:
  • Stock
  • Consulting agreements
• Minimize the probability of contingent payments, such as:
  • Earnouts
  • Seller financing
  • Escrows/holdbacks

Here are some tips for you to maximize your deal structure.

Prepare for the Sale

One of the best methods for ensuring a favorable deal structure is to prepare your business for sale well in advance. 

For example, when I assess a potential client’s business, I identify potential major risk factors that could lead to an earnout as a component of the transaction structure. If you minimize risks that a buyer is likely to see in your business, it’s less likely a buyer will propose contingent payments in the first place. The lower the overall confidence level a buyer has in your company, the more likely they’ll propose a less favorable deal structure. 

One of the most critical areas of preparing your business for sale is the degree to which your business is dependent on you, the owner. If the buyer considers a business to be highly dependent on its owner – with the owner having close personal relationships with employees and customers, or if the business’s identity is tied closely to the owner – the buyer will consider the business excessively risky. As a result, they’ll counter the risk through a low purchase price or other mechanisms designed to limit their risk. On the other hand, if you’ve developed a strong management team and your business doesn’t depend heavily on your personal involvement, you’ll receive more cash down at closing. 

Most earnouts and other restrictive deal mechanisms are proposed because of major risks or other forms of uncertainty that may exist in a business. These risks can be mitigated to some extent in advance of the sale. Even if you don’t plan to sell your business in the near future, it’s still sensible to minimize risks from an operational standpoint. Mitigating risks will reduce the possibility of a buyer proposing restrictive deal mechanisms and increase your business’s value. Value is simply an element of potential return and risk. The lower the risk, the higher the value. 

One of the best methods for ensuring a favorable deal structure is to prepare your business for sale well in advance. 

Conduct Pre-Sale Due Diligence

Pre-sale due diligence is vital to ensuring you receive a favorable deal structure. By performing your own due diligence in advance, you’ll be able to identify and minimize risks before you put your company on the market. When buyers uncover risks within your business, not only will they view it as less valuable and potentially reduce the offer price, but they might also propose contingent payments or other protective mechanisms. 

Yes, it’s expected for buyers to propose such mechanisms in the later stages of the deal if they uncover problems that weren’t initially disclosed, even if they didn’t include these mechanisms in their LOI. The best method for avoiding the potential of protective payment mechanisms being introduced later in the process is to retain a third party – such as an accountant, attorney, or M&A advisor – to perform pre-sale due diligence and then address the problems they uncover before you go to market.

As a seller, it’s critical to understand the role of due diligence and be prepared for the thoroughness of the process. Nearly every buyer will perform meticulous due diligence. This means you should be emotionally prepared to survive this painstaking period and not take personal offense at a buyer’s requests. Buyers will become nervous if you overreact or become secretive during the process. Those behaviors represent an increased risk for the buyer, making them more likely to structure part of the purchase price as contingent payments, such as an earnout or seller note. 

Maximize Negotiating Posture and Momentum

Aside from conducting pre-sale due diligence, the next best tools in your arsenal for ensuring a favorable deal structure are a strong negotiating position and expert negotiating skills. Your negotiating posture is strengthened by negotiating with many buyers and not having to sell. Your posture can also be maintained by displaying an even disposition throughout all discussions with the buyer. 

Setting expectations with buyers is critical. Many buyers will attempt to feel you out to detect the likelihood of re-trading. Re-trading is when the buyer attempts to renegotiate the purchase price at later stages in a transaction after an LOI has been signed and agreed upon. During due diligence, unscrupulous buyers will search every nook and cranny of your business for any flaw they can find. Opportunistic buyers will then use these flaws as negotiating leverage to renegotiate the price or terms. As part of this strategy, they may overreact to any “bad” news and tell you how distraught they are. But then they’ll let you know that they might be willing to move forward if you agree to lower the price or restructure a portion of the consideration as an earnout. 

By preparing your business for sale, you minimize the number of flaws a buyer may discover during due diligence that they can later use as leverage against you. 

Momentum is also a critical component to consider during negotiations. Many buyers may intentionally slow down the process to wear you down. Most buyers know that several months of negotiations and the obligation to deal exclusively with them puts many sellers in a weak position and subjects them to last-minute negotiating ploys. 

By properly preparing your business for sale, you minimize the number of flaws a buyer may discover during due diligence that can later be used as leverage against you. 

Build and Maintain Trust With the Buyer

Trust is the most powerful weapon for preventing a restrictive deal structure. Buyers often propose contingent payments such as earnouts because they lack trust in the seller. By building a trustworthy and respectful relationship with the buyer, you reduce their perception of risk, thereby helping to ensure they don’t propose a restrictive deal structure. This means that how you conduct yourself is of particular importance in maximizing your deal structure. You must present yourself as a level-headed, trustworthy individual in all interactions. Never lose your cool. Never. Ever. Losing your temper, even once, can spell doom for your entire transaction structure. 

Another key to developing trust is honesty. When selling a business, truth is the safest lie. Buyers will conduct painstakingly meticulous due diligence that’s bound to uncover even the most infinitesimal of inconsistencies. If a buyer discovers you’ve been anything but forthright, they’ll likely pile on the protections in the form of earnouts, holdbacks, reps and warranties, and other mechanisms designed to reduce their risk. A lie can erode even the most attractive deal. At even the whiff of withholding information, the buyer will construct numerous provisions to minimize the impact of any additional untruths and their attendant risks – that is, if they don’t walk away entirely. If the buyer believes you to be a strait-laced, conscientious, reliable individual, they’re more likely to propose a conservative deal structure with more cash down at closing.

Trust is also important in the event of disputes. Even the most carefully drafted agreements don’t guarantee a painless transaction. Most earnouts and other contingent payments, such as holdbacks, lead to disputes. But if the parties share a fair and trusting relationship, even the most intractable conflicts can be quickly and efficiently resolved. In the absence of trust, the disputes can quickly become costly and consume enormous amounts of time and money.