Introduction
Selling a business can be a complex and overwhelming process. Business owners must grasp the fundamental elements of the deal, including its structure and terms to ensure they get a fair deal.
At Firebird Capital, we are committed to transparency and fairness in our deals. In this blog post, we will explore the common facets and terms of a deal and Firebird Capital's approach to them.
Click here to visit our Deal Structure page on our website and learn more.
Key Deal Structure Terms and Concepts
To ensure a deal works for all parties, it is crucial to understand the key terms and concepts that are often included in the sale process. Let's explore some of these terms and their significance:
Deferred Consideration - What is it and Why is it used?
Deferred Consideration, or Earnout, is an arrangement where a portion of the purchase price is contingent on the future performance of the business.
There are a few key reasons for using deferred consideration:
Accurate Valuation: Some businesses might have uncertain future earnings potential due to market volatility, industry changes, or other factors. Deferred consideration allows an investor to better assess the actual value of the business based on its post-acquisition performance, rather than relying solely on historical financials. This often allows an investor to offer a higher valuation, despite uncertainty, as if the business continues to thrive and grow post acquisition, a higher value is justified.
Mitigating Overpayment: Deferred consideration can help prevent overpaying for a business that appears successful at the time of acquisition but might not sustain its performance in the long term. By tying a portion of the payment to future performance, an investor can avoid potential losses if the business does not meet expectations.
Business Transition: The level of change when selling a business can bring uncertainty if not managed well. By deferring some portion of consideration, all parties are incentivised to ensure a smooth transition.
Firebird Capital strategically designs earnouts to consider the inherent risks of each specific business, while ensuring fairness, transparency and attainability. This approach creates an opportunity for business owners to realize the full value of their ventures.
Our unwavering commitment to this principle is exemplified by our track record of fulfilling 100% of earnout commitments.
Deferred Consideration - How Much to Expect
The question commonly asked is: how much of the value is deferred? The answer varies greatly. While some deals involve upfront payment for the entire value, such cases are rare. In contrast, in certain instances, as little as 20% may be paid upfront.
At Firebird, we understand the importance of providing a substantial upfront payment to business owners during the acquisition process. Typically, we offer up to 67% of the total value as an upfront payment.
Handover Period
The handover period refers to the time during which the seller assists the buyer in transitioning the business smoothly.
Firebird Capital recognizes the importance of a well-structured handover period to maintain the business's stability and ensure a successful transition. The typical handover period in one of our deals is 6 to 18 months, depending on the unique circumstances of the business.
Percentage of Shares Acquired
In essence, when selling a business, the owner essentially is transferring ownership of 100% of the shares to a buyer. At Firebird Capital, our approach remains consistent with this principle.
However, there are instances when a business owner indicates an interest in initially selling a majority, but not all, of the shares. This allows for a collaborative partnership with Firebird over a period of 3-5 years, aimed at accelerating growth. After this duration, both Firebird and the business owner jointly sell, a strategy that also aligns well with our objectives
Cash Free, Debt Free and with a Normalised level of Working Capital
Most investors acquire businesses on a "cash free, debt free and with a normalised level of working capital" basis.
This means that on top of the value paid over to the owner for the business, an investor will also pay over any excess cash in the business bank account. Similarly, the owner would be expected to pay any outstanding debts and to ensure debtors had not been squeezed / creditors stretched to flatter the cash position.
Sweat Equity
Sweat Equity refers to shares that are typically allocated to the existing management team at little to no cost. The purpose is to incentivize and motivate them to actively contribute towards enhancing the business's performance and value, aligning their goals with those of the investor. When determining which party to sell to, this aspect frequently plays a pivotal role. Many business owners prioritize taking care of the team they have assembled and ensuring that the management team fully supports the transaction.
At Firebird Capital, we grant shares to key team members, reserving up to 20% of the shares for this purpose. This approach means that if the business achieves strong performance, those driving that success are duly rewarded.
Conclusion
Selling a business can involve many terms and concepts that are new to a business owner. To ensure a deal works for all parties, it is imperative that the structure and key terms are well understood. This article has sought to explain some of the most commonly used deal structure terms.
At Firebird Capital, we are committed to fair and transparent deals. One of the ways we achieve this is by sharing our approach to some of these key structure points. For more information, click here to visit our website.
Comments