M&A Activity -- Expect a Surge in Mergers
The buyer will also perform this analysis and it is rare that a buyer's conclusion equals that of the seller; hence a negotiation will be necessary. Frequently, the buyer will agree to pay the seller for the Adjusted Book Value at closing and then a royalty on actual collected sales over a period of time. These royalty rates range from 3-10 percent, for terms of three to five years.
The royalty rate and the term depend on the buyer's analysis of the profitability of the seller's revenues when produced either under the new management or in the buyer's plant, if the seller's plant is to be closed.
Once selling shareholders have agreed to a reasonable price, they should consider other possible transaction terms. These should deal with structure: Do you want the consideration paid in cash or the stock of a publicly traded company? Are you willing to accept some or all of the consideration in the form of secured seller financing (you receive payments secured by a promissory note that is secured by your company assets)?
Are you willing to accept some or all of the purchase price in the form of a performance-based earnout paid over time? Earnouts are usually based on earnings over three to five years and are paid annually by the buyer. Most frequently they are 10 percent to 30 percent of the purchase price and are based on agreed upon operating profit or EBITDA performance.
Why Accept Anything Other Than Cash?
Buyers are motivated to use earnouts because they may fear that shareholders, who now have bulging bank accounts and who are staying on to manage the company, will lose their motivation for profit performance or will suddenly decide to take their money and leave the company to play golf. Buyers may also propose a seller-financing component because the purchase price is not totally financible through conventional sources.
