In our previous article, we delved into the fundamentals of buyer value creation. This time, we shift our focus to its impact on sellers.
Despite the efforts of both parties, buyers and sellers may not agree on value – a seller may have a more optimistic perception of value that does not align with the buyer’s risk-adjusted perspective. This value gap is either successfully negotiated and bridged or can result in an unsuccessful transaction. To bridge value gaps, transaction advisors work with the buyer and seller to adjust the purchase price and nature of the transaction by using any one or a combination of the following:
- Earn-out – A portion of the purchase price is contingent upon the target’s financial performance after the acquisition. Earn-outs typically last for up to two years. They are often linked to future revenue or EBITDA, which is usually based on the financial forecast provided by the seller during the sale process. Additionally, qualitative earn-outs are possible where payments are tied to specific outcomes, such as technology development or product launches.
- Retained Interest – The seller retains a portion of their equity, typically between 10% and 20%, allowing them to benefit from the value created through the buyer’s activities aimed at increasing that value. The seller can realize this retained value either through a downstream sale or, depending on the buyer’s intended holding period, by having the buyer repurchase the equity at market value based on a pre-determined trigger (such as the holding period) at a future date.
- Minority Investment – As an alternative to a majority purchase, a buyer could seek to position for a minority investment in the target. While this may not meet the seller’s objectives, it may allow the buyer to see/realize upside value over time and position for a downstream purchase of the business. Buyers often lock in an option and value for full acquisition of the company at the time of initial investment.
In summary, creating value for buyers is vital to the sales process. It justifies the transaction and helps determine the amount and structure of the purchase price. In most transactions, buyers and sellers have different perceptions of value. Therefore, minimizing and bridging these value gaps is essential for a successful outcome.
As value and growth advisors on the sell side, we aim to create value for the seller while minimizing the potential value gap. A well-structured, multi-step sell-side process can help identify and address this gap before the letter of intent is issued. Closing the value gap is crucial for both parties to achieve a successful transaction.
This article is part of a comprehensive series exploring buyer value creation. You can find another article here and download the complete guide here.
About SD Capital
SD Capital is a premier, full-service, value advisory and investment banking practice that assists middle-market companies in creating and maximizing business value. We provide strategic evaluation and execution of various downstream sales and monetization pathways. With decades of combined executive experience running, owning and advising private companies our team is uniquely positioned to guide owners through the complex process of growing and selling their companies.
Learn more at www.sdcapital.com or contact the team directly at contact@sdcapital.com.
Schneider Downs Capital LLC is a subsidiary of Schneider Downs & Co., Inc.
