Deal Structure Versus Price in Tech M&A

Although many prospective sellers of tech companies initially think of the price they can get for selling their company, the structure of the sale is often equally, if not more, important. Deal structure means the terms and conditions of the deal. For instance, is the transaction structured as an asset deal, where the buyer acquires some or all of the assets of the seller's company? Or is it a stock deal, where the buyer acquires equity shares in the seller's company? Is it an all cash transaction? Or does it involve some combination of cash, seller note, earnout, or rollover, where the seller takes on some amount of risk regarding the future of the company and defers some of the proceeds of the sale over time?

Deal structure over price

Sometimes a higher purchase price offered by a prospective buyer can be less attractive than a lower price offer that is better structured. Here is an example.

Buyer 1: $20 million

• $5 million cash at closing
• $5 million from a guaranteed seller note paid at end of year 1
• $5 million paid at end of year 2 if contingencies are met
• $5 bonus based on goals tied to a four-year employment agreement
• No provisions for let-go employees

Buyer 2: $15 million

• $13.5 million at closing
• $1.5 million paid at end of year 1 if escrow contingencies are met
• Two-year employment agreement, with non-compete for three years
• Large severance bonus for let-go employees

Although buyer 1 submitted the higher offer, it is structured in a way that is riskier than buyer 2's offer. If contingencies are not met in the buyer 1 deal, the seller may get as little at $10 million: $5 million at closing and another $5 million after one year as payment via the guaranteed note. In addition, the seller would be tied to the company for an additional four years and there would be no payments to any of the seller's employees that are let go in the deal.

By comparison, the seller is guaranteed $13.5 million in Buyer 2's offer. The seller would only be tied to the company for two years, with a non-compete agreement for three years, and there would be a large severance bonus for any let-go employees.

Most buyers in today’s M&A market would tend to view Buyer 2’s offer as the better one because of its higher guaranteed payout. Sellers would also view positively the shorter length of the employment agreement and the bonus for let-go employees.

Deal structure can evolve

Deal structures are not necessarily static. A deal structure initially proposed by a prospective buyer can change during the negotiation that typically happens between the seller and buyer during the M&A process. In the previous example, the seller can reasonably counter Buyer 1’s offer by requesting a greater cash payout at closing, a shorter employment agreement, and some financial protection for let-go employees.   

Let’s look at an actual example of how the deal structure evolved for a Corum client during M&A negotiations.

The seller is this example was an international company valued at just under $3 million. There were three serious bidders. The first was a strategic tech company. The second was a major PE firm interested in making a bolt-on deal. The third was a smaller PE firm that was looking at this as a platform deal.

During the first round of offers, the strategic tech company offered $12 million, all in cash. The larger PE firm also offered $12 million, but half in cash and half as earnout. The smaller PE firm, made an initial offer in the low teen millions. However, the Corum team countered, pushing for a higher offer. In the second round, the strategic buyer dropped out. The larger PE firm increased its bid to $28 million, half in cash, half as earnout, and with a stock consideration. The smaller PE firm increased its offer to just above $28 million, to be paid partly in cash, including rollover equity and an earnout. In the third round, the smaller PE firm again increased its offer. This time to $52 million, partly in cash, with rollover equity, earnout, and a seller note as part of the structure. The larger PE firm could not match that offer. So the seller signed an LOI with the smaller PE firm.

This sort of evolution in deal structure requires an auction environment where multiple buyers contend for the deal. That buyer contention inevitably makes for higher offers and better deal structures for the seller.

Deal structure and risk

As the Corum client example demonstrates, there is a direct relationship between what a buyer is willing to pay and the risk the seller is willing to share. Deal structure terms such as earnouts, rollover equity, seller notes, and stock considerations all depend on the future performance of the company after the sale, and as such, involve risk for the seller. For instance, in an earnout, the seller agrees to receive future payment if certain financial goals are met after the business is sold. But what if those goals are not met? In that case, the seller will not receive the earnout payment. Or think about a seller note, in which the seller agrees to accept a portion of the purchase price in a series of deferred payments. What happens if the business fails and the note is not guaranteed? In that case, the payments won't happen.  

So if you want the maximum amount for the sale of your company, be willing to take on a large amount of risk by agreeing to terms such as earnouts in the deal structure.

Corum Can Help

A professional advisory such as Corum can help you get an optimal deal, one with excellent structure. A key element in reaching an optimal deal is creating an auction environment where multiple serious buyers contend for the deal. Corum's global search process backed by the largest buyer information database in the industry is designed to bring multiple serious buyers to the table, and weed out the so-called “bottom feeders”. And Corum's team, comprised of ex-CEOs who have years of experience building and selling companies as well as interacting with buyers in the M&A process, will provide the assistance and guidance you need to get you to an optimal deal.

Selling your company may be the most important transaction of your life. Make sure you have the right people by your side to help you reach your goals.