Deferred consideration – the whats, whys and hows

Deferred consideration – the whats, whys and hows

It has been an increasing trend in private company acquisitions for some of the consideration to be deferred.

What is deferred consideration?

Where consideration is deferred, the buyer obtains the shares or business at completion but pays part of the purchase price at a later date/s.

The deferred consideration may be a fixed amount, or it may be linked to the future performance of the business acquired – this is often referred to as an ‘earn out’.

Why is this a popular structure?

For the buyer, the benefits are clear: it does not have to find all the purchase price upfront and avoids the need to deplete cash reserves and/or the need to borrow. It also means that, providing the acquired business is profitable, the buyer can part-fund the acquisition from future profits of the business.

For the seller, the benefits are not so obvious. Quite apart from the fact that the seller has to wait for its money, they also take the risk that the buyer will not be in a position to pay the deferred part of the consideration when it becomes due. However, the buyer is likely to be willing, or able, to pay a higher price if some of the consideration is deferred.

How is the structure implemented?

The deferral mechanism will be drafted in the transaction documents implementing the sale of the company or business.

The seller may require security to be comfortable that the deferred consideration will be paid when due. This can take many forms, including a charge over the assets or shares of the target company and/or the buyer – similar to how a bank takes a mortgage over your house.

If the deferred consideration is linked to future performance, the seller will want to ensure that the performance figures cannot be artificially manipulated. Often such structures will only be appropriate where the seller has a continued ability to influence the performance of the target business.

Deferred consideration structures can be complex from a tax perspective and so it is important to obtain suitable tax advice to ensure that the tax treatment is acceptable for buyer and seller alike.

It seems that these structures are here to stay and, if used appropriately, are a useful tool to deal-making.