Deferred consideration on business sale – risk with no reward?

Reasons for deferred consideration

Sometimes it is just not possible for a seller to negotiate payment in full for their shares on completion of a share sale. This may be because:

• the buyer does not have access to sufficient funds at that time
• the buyer is not sure that the price negotiated reflects the true value of the company and wants to see if profits can be maintained following the purchase
• the buyer wishes to retain the seller’s input to the business and provide an incentive

Structuring the sale so that some part of the payment for the shares is deferred can therefore be useful to facilitate the sale and may take the form of:

• payment by instalments
• payment dependent on future profits (known as earn-out); or
• payment by the issue of shares in the buyer to the seller as an incentive to the seller for his continued performance (where the buyer wishes to retain the services of the seller).

But good advice from lawyer and accountant is required to avoid the pitfalls of such a deal.

How might this work?

The owner of a double-glazing company was keen to retire but was finding it difficult to find a buyer. One of his competitors was keen to acquire the company but did not have all the funds available in cash as he had not long before acquired another company and had already incurred heavy borrowing. The price was agreed at a satisfactory level to the seller but on terms that a portion of the sale price would be payable in instalments over 2 years from completion of the sale, some of the price would be dependent on profits earned and the seller would also receive a small shareholding in the buyer.

What could go wrong?

Quite a lot, actually. What if:

• the buyer goes into decline or worse still becomes insolvent over the next 2 years? The buyer may genuinely have believed that he could meet these commitments but be badly affected by a recession or downturn in that particular industry.
• the buyer cannot resist a little manipulation of the profit figures in the accounts over the next 2 accounting periods? The buyer may hive off some of the profits and business rightly attributable to the seller’s business into other businesses of the buyer so that he does not have to make full payment to the seller as the agreed profit targets will not be met.
• the seller finds he cannot work with the buyer and resigns but is subject to good leaver/bad leaver provisions in the agreements he signed and is classified as a bad leaver? The seller receives little value for his shares in the buyer which he is required to relinquish on his departure from the business.
• the seller finds that he has to pay tax on the disposal of all his shares before receiving the full consideration for them? The seller did not take tax advice to plan for the payment of tax.
• If you find yourself in the position where deferred consideration is offered for your shares then it is worthwhile taking early advice to avoid problems.

We can provide advice as to ways of protecting your position to help you achieve the full consideration for your shares and protect your interest going forward if you find you are tied into the buyer e.g. by way of earn-out or shares in the buyer.

Contact our corporate and commercial law experts today

If you would like advice on how to set up a new business in the UK or relocate your business to the UK, talk to our experienced corporate or commercial solicitors. Call us today on 01895 207264 or email corporate@ibblaw.co.uk.