I attended an interesting Corporate Finance Workshop yesterday (the 27th September) run by Roffe Swayne as part of a Surrey Chamber of Commerce monthly series.
The Title was ‘The Corporate Finance Transaction – Unplugged’ – a presentation and discussion around the various issues that arise before, during and after a corporate finance transaction, and was chaired by Kate Hart and Matt Katz.
One of the subjects that came up was the issue of differed consideration contingent of the future performance of the business. It is very common practice to have a large part of the sale proceeds deferred and it is usual for the sum to be based on the future business profits. The opinion of the room was that it is quite a challenge to ensure that the future business performance can be fairly defined and measured from the vendor’s perspective.
However, as any decent accountant will tell you, a P&L is easy to manipulate – particularly in a downward direction. Chuck in some restructuring costs one year, blend in some asset write-downs the next, apply a liberal sprinkling of provision accruals – next thing you know the deferred payment has all but disappeared.
Many delegates were of the opinion that the vendor should ‘manage their expectations’ and assume that there would be a significant shortfall in the future payments. At least one admitted that he had advised a client to assume that it would be zero.
My own take is that it is important for the vendor to understand that the business that is being sold is not the business that is being purchased.
The purchaser will, it is hoped, want to take the business forwards into new markets and launch new products. If this isn’t the plan, then the vendor has done a very poor job of preparing the business for sale and will more than likely be getting a very poor offer.
However, here is the double-edged sword.
The irony is that the better a job the vendor has done of creating a scalable business that can attract a high multiple upon sale – the easier it will be for the purchaser to manipulate the P&L to reduce the future consideration.
It isn’t unusual for a vendor to purchase a business in order to obtain the brand, distribution and market penetration – and to then to use these strategic assets to leverage their own existing products. In some cases the ongoing products from the original business may even be dropped. A poorly advised vendor may find them selves with their deferred consideration based on the profit from a product that has sidelined whilst the purchaser has transformed the combined business by leveraging the brand loyalty.
The lesson is three fold:
First of all, if you are thinking of selling your business make sure you are getting professional advice.
Second: be very careful to understand your purchaser’s motivations for acquisition so that you can structure your deferred consideration in an appropriate way.
Third: Do not assume that you will get all, or even the majority, of your deferred consideration.