Add your information to subscribe
The headline “sticker price” (total deal value) is usually the most important aspect of a transaction that people pay attention to when reviewing an offer to buy an advisory practice. However, transactions can be quite a bit more complex in actuality. We can use buying a car as an example. The “sticker price” or MSRP is what you initially see on a car window. As we know, this does not include rebates, promotional offers or the dealer’s discount. In fact, no one ever pays the “sticker price” when buying a car. Furthermore, we know other factors impact the deal we receive on the car such as the amount of money down, term of the loan and credit worthiness. The real price of the car is quite variable from buyer to buyer and seller to seller.
Now that we’ve conceptually discussed transactions, let’s get specific to advisory practices. The underlying structure of the deal can have a dramatic impact on both the amount of money ultimately received by the seller (or paid by the buyer) and the predictability of those cash flows over the life of the payout. Both the buyer and a seller must consider, from their respective positions, which type of payout is the most advantageous and appropriate given the goals they are each trying to achieve. Whether it be a cash payment, earn-out or set installment payments, it is critical that the deal structure properly balances the goals of all parties. Particularly important is the relationship between the down payment and earnout.
The major benefit of the down payment, usually, is receiving a large percent of the deal value upfront. The down payment can represent from 25% to upwards of 60% of the deal value, depending on the situation. An additional benefit is that this is a guaranteed payment that is (generally) irrevocable. There is no consideration given to the time value of money, from the seller’s perspective, because the seller has the ability to access that money right away as opposed to installment payments that are spread out over several years. Collectively, the benefit of receiving a larger portion immediately results in de-risking the seller by “taking chips off the table” from the start.
The two major benefits of earn-outs and other incentive-based or performance-based compensation models are incremental upside for the seller and additional flexibility in deal structure for the buyer. The seller is not capped by a fixed valuation at a point in time in an earnout structure, but rather “earns” consideration for actual performance post transaction and usually over a specified time period. On the other hand, performance-driven payments reduce risk for the buyer by incentivizing the seller to continue growing their asset base or achieving defined profitability metrics. The buyer isn’t locked into a set deal payment schedule that in turn could make the seller no longer is incentivized to grow.
Determining which structure makes the most sense is always deal specific. Some buyers offer greater flexibility in deal structure than others. However, the structure should be designed with the aim of aligning goals, incentives, and expectations for all parties. For more on Deal Structure see the Example Deal Structure Illustrations.
Example Deal Structure Illustrations
The following assumptions apply to each illustration:
1) Traditional Down Payment Structure
Down payment: 30%
Total Purchase Payments (including interest): $5,885,000
Apella Capital, LLC, provides this communication on this site as a matter of general information. Information contained herein, including data or statistics quoted, are from sources believed to be reliable but cannot be guaranteed or warranted. Nothing on this site represents a recommendation of any particular security, strategy, or investment product. The opinions of the author are subject to change without notice. All content on this site is for educational purposes and should not be considered investment advice or an offer of any security for sale. Please be advised that Apella Capital do not provide tax or legal advice and nothing either stated or implied here on this site should be inferred as providing such advice. Apella does not approve or endorse any third party communications on this site and will not be liable for any such posts.