A seller can offer a range of cash and / or equity in exchange for your company. The buyer has expert advice supporting the structure of their offer. You should not go into negotiations at a disadvantage. If you do not have the expertise yourself you should get expert support to help you define and negotiate for the package that suits you best.
In exchange for transferring ownership of a business, a seller will receive ‘consideration’ from the buyer. Consideration in the context of a business sale comes in the form of either cash or new shares in the combined business.
Cash vs. equity consideration
Your preference for either cash or equity consideration is shaped both by your personal circumstances and how interested you are in being involved in the larger, combined business. Many selling founders will look to cash out at least a portion of their proceeds in order to repay debts or compensate for lifestyle sacrifices made during the business’ initial phase. Meanwhile, receiving shares in the combined business will allow you to benefit from any synergies delivered through the transaction.
If the buyer is planning to keep you involved in the running of the business, at least during the fiddly integration phases, then they may like to use equity consideration to tie your motivations to the transaction’s success.
A financial sponsor, speaking to you directly and not through a portfolio company, will not be able to offer you equity in a combined group but may well want to keep you running the business. To align your interests with theirs, they may offer you a package that is likely to include equity options that vest once performance targets have been met – often referred to as ‘sweat equity’. These performance targets are likely to include the returns made by the sponsor on the acquisition, alongside other operating metrics.
The appeal of equity
Alongside keeping you involved, buyers may also benefit from using highly-valued shares as an ‘acquisition currency’ to purchase lower-valued businesses. If, once a transaction completes, the combined earnings of the two businesses continue to be valued at the acquirer’s higher multiple,then ‘value’ has been created. This approach was especially popular in the 1980s when huge conglomerates were formed by repeated ‘all stock’ acquisitions. Many have since been broken down again.
Finally, to reduce their risk of overpaying for the transaction, the buyer may want to include an earn-out agreement. When using an earn-out, a portion of the consideration will be spread across a pre-agreed time period – often between three and five years. Each of the agreed payment dates will include a range of performance benchmarks, each one with corresponding consideration values. Each time a payment is due, the size of the payment will be determined with reference to these benchmarks. Using this structure, if the business performs well the buyer ends up paying more, and if it under-performs then they pay less – reducing the valuation risk for both parties.
An Ithaca expert can help you define and negotiate for the consideration package that suits you best.