In the world of mergers and acquisitions (M&A), a common misconception among business owners is that the agreed-upon sale price is the exact amount of cash they will walk away with. While a signed deal letter feels like the finish line, it is often just the starting gun for a complex negotiation of terms that can significantly alter the final net proceeds.
The secret lies in understanding how the devil is in the details of the deal terms. Here we unpack all the important bits.
1. The Disconnect: Value vs. Price vs. Proceeds
Value: This is the intrinsic worth of a business, often determined by an analysis of its financial performance, market position, and future potential. It is the number that drives the initial discussions and valuations.
Price: This is the headline number in the deal agreement i.e. the agreed-upon amount the buyer will pay for the company. This is what everyone celebrates when the deal is announced.
Net Proceeds: This is the actual cash or value a seller receives after all adjustments, holdbacks, and transaction costs are accounted for. This is the number that lands in the seller's bank account.
The challenge is that Price ≠ Net Proceeds. This gap is where many a seller's expectations get a rude awakening.
2. The Deal Terms That Reshape the Outcome
Let's break down some of the key terms that can turn a $10 million price tag into a very different number in your pocket.
a. Working Capital Adjustments
Imagine a business needs a certain amount of cash on hand to operate smoothly. This is its "target working capital." In a deal, the buyer wants to ensure they are getting a business that can continue to run without immediate capital injections.
How it works: If the company's working capital at closing is below the agreed-upon target, the sale price is reduced by that amount. If it is above, the price may be increased.
Real-world example: A software company is sold for a headline price of $20 million with a target working capital of $2 million. A week before closing, a key client is late on a large payment, and cash on hand drops to $1.5 million. At closing, the buyer will likely adjust the price down by $500,000, reducing the seller's proceeds.
b. Escrows and Earnouts
These are common ways for buyers to manage risk and align incentives.
Escrow: A portion of the sale price is held in a third-party account for a period (e.g., 12-18 months) to cover potential future liabilities, such as legal issues or breaches of representations and warranties. If no claims are made, the money is released to the seller.
Earnout: A portion of the payment is contingent on the business hitting specific performance targets (e.g., revenue or EBITDA - Earnings before Interest Tax Depreciation and Amortization) post-closing.
Real-world example: A founder sells their marketing agency for $5 million upfront and a potential $3 million earnout based on achieving 20% annual revenue growth over the next two years. The founder assumed they would hit the target easily, but the new corporate parent changes the agency's sales strategy and integrates its client base, making the target unreachable. The founder gets the upfront cash but misses out on the $3 million earnout, a significant chunk of the total potential value.
c. The Impact of Transaction Costs
This is straightforward but often underestimated. Legal fees, banker fees, accountant's fees, and other advisory costs are typically paid by the seller from the gross proceeds. These costs can easily run into the high six or even seven figures on larger deals.
3. Strategies for Win-Win Outcomes
So, how can a seller navigate this minefield and ensure the net proceeds align with their expectations?
a. Do the "Net Proceeds" Math Early and Often
Work with your M&A advisor and accountant to model the deal from the very beginning. Create a detailed waterfall analysis that accounts for working capital adjustments, escrows, transaction costs, and any potential earnout scenarios. Don't just focus on the headline price; focus on the cash you will actually receive.
b. Proactively Manage Your Business' Financials
A few months before a potential sale, work with your CFO or accountant to clean up your balance sheet. Manage working capital closely, reduce unnecessary expenses, and ensure your financial records are impeccable. This proactive approach can minimize or even eliminate negative working capital adjustments at closing.
c. Understand the Buyer's Perspective
A win-win deal is built on empathy. A buyer is not trying to nickel-and-dime you; they are trying to manage risk and ensure the business they are buying is sustainable. Understanding their concerns about liabilities or post-deal performance can help you structure a deal that addresses these issues fairly, such as with a reasonable escrow or a clearly defined earnout tied to specific, achievable metrics.
d. Negotiate for Clarity and Simplicity
When it comes to deal terms, clarity is king. Push for simple, transparent clauses for working capital and earnouts. The more complex and subjective the terms, the more room there is for future disputes and a misalignment of expectations.
Conclusion
The journey from a handshake agreement to a final cheque is filled with nuances. While the headline price of an M&A deal is what captures the headlines, the real story for the seller is told in the net proceeds. By focusing on the details of the deal terms, anticipating potential adjustments, and working with a savvy M&A team, sellers can navigate the complex M&A tango and ensure that their final payday truly reflects the value they have built.