Negotiation of an M&A deal will be smoother if the business owner has a basic understanding of deal terms, which may not be used in the ordinary course of running their business. Familiarity with deal structures will position owners better in negotiations, improve their ability to market themselves, and may result in the deal closing faster.
Business owners should prepare themselves for a deal by familiarizing themselves with the definitions below prior to beginning an M&A process.
Common Deal Terms
- Enterprise value is the value of the business at a specific point in time. It is often determined by a multiple of EBITDA, e.g. EV = 5x trailing twelve-month EBITDA (the operating profits generated over the last year).
- Total Purchase Price/Consideration is the amount the business owner will receive in the transaction. The Purchase Price may differ from the enterprise value based on the percentage being sold and how the deal is structured. The Purchase Price/Consideration may be paid at close or in installments and may be paid in one or more forms (e.g. cash, stock, earnout, seller’s note).
- Cash at close refers to how much cash the business owner will receive the day the transaction closes. The source of cash at close will depend on how the buyer has chosen to structure the deal. Sellers often want to maximize cash at close, but this may result in lower total consideration.
- Equity is an ownership interest represented by a share or unit. Equity in a public company is easily sold on public market exchanges and valued by looking at the current share price. Public company equity, however, can be volatile as liquidity on public market exchanges can cause share prices to move up and down significantly day to day. Equity in a private company is typically illiquid and the price per share or unit is determined by several valuation methodologies.
- Rolled equity is the equity in the company being sold that the seller(s) retain after the transaction.
- Seller’s note is a loan from the seller to the buyer to help finance the deal. The seller will earn interest on the outstanding principal of the note (generally aligned with market rates). The principal and interest will be paid from the company after closing (generally over several years).
- Earnout is a portion of total consideration that is paid out over time (typically a few years) from the company. Earnouts can be structured as upside participation for the seller and/or downside protection for the buyer, helping the buyer ensure they get the economic performance they expect post-close.
How These Terms Are Used at Tide Rock
Different buyer types will emphasize or avoid different deal structuring components. Tide Rock Holdings avoids using bank debt (including seller’s note) but is otherwise very flexible and creative in structuring deals that achieve both the seller’s and Tide Rock’s goals.
Tide Rock offers the option to receive distributions with rolled equity and allows sellers to contribute equity into its holding company. The seller contributes their equity for an equivalent value of Tide Rock units. Units provide indirect ownership of the business the seller is selling, access to similarly situated but diversified businesses, and quarterly distributions. This portion of total consideration is not subject to capital gains tax at close.
Here is a breakdown of how Tide Rock Units work in exchange for equity:
- No Contribution:
- Buyer offers $10m cash and/or Units
- Seller chooses 100% cash
- Seller pays ~38% cap gains tax (California after Fed, State, Obama, etc.)
- Seller is left with ~$6.2m to invest elsewhere
- Buyer offers $10m cash and/or Units
- Seller takes $9m in cash and contributes $1m of company’s equity into Tide Rock Holdings for $1m in units
- Seller pays no immediate cap gains tax on $1m of total consideration; saves ~$380k in cap gains taxes
- Seller has a principal value of $1m in Tide Rock Holdings units vs $620k to invest if they had taken cash
- Tide Rock Holdings units generate growing quarterly distributions that provide the seller ongoing income post-transaction
- Example: A seller with $1m in Tide Rock units would realize ~$38k greater annual return than a seller who took $1m in cash and reinvested the after-tax proceeds of $620k, assuming both investments generated a 10% annual return
- The seller gets access to an exclusive investment vehicle, with an opportunity for significant appreciation, that they otherwise wouldn’t
Tide Rock Holdings has experience working with small business owners and operating leaders to structure majority sale deals that achieve both their personal and professional goals. If you are interested in learning more, give us a call today and talk to a member of our management team.
“The team at Tide Rock has been fantastic to work with. They add tremendous value in both strategic thinking as well as tactics. They are there when we need them and allow the management team to operate without micromanaging. I could not ask for a better investor or partner.”
– Peter Heald, CEO, Signature Analytics