Understanding deal structures: earnouts, deferrals and more

Two transactions at the same headline price can carry very different levels of risk. Structure determines when value changes hands, what has to be true for it to be paid, and who carries the risk if an assumption proves wrong.

For a buyer who cannot yet evidence every assumption, structure is the most useful tool available.

Deferred consideration is a portion of the price paid after completion, usually on a fixed date. It is simple to document and straightforward to administer, but it does not necessarily tie payment to performance.

It is most useful where the uncertainty is about the completion position rather than future trading: for example, where the final working capital or debt position is not yet agreed.

An earnout ties part of the consideration to performance after completion, usually measured against revenue, gross profit or EBITDA over one to three years. It can bridge a genuine gap between buyer and seller expectations where the seller believes in the forward case.

Earnouts are also the most frequently disputed mechanism in SME transactions. They work when the measure is unambiguous, the calculation is mechanical, and the buyer's conduct during the earnout period is constrained by clear obligations.

Seller finance leaves part of the consideration in the business as a loan, ranking behind senior debt. It aligns the seller's interest with the business performing, and it reduces the buyer's funding requirement.

Retention arrangements are a different tool with a similar purpose: they hold value back against a specific risk, such as the departure of a key individual or the loss of a major customer.

Most SME transactions are priced on a cash-free, debt-free basis with a normal level of working capital. The mechanics look technical but the principle is simple: the buyer acquires the operating business, and the seller takes the surplus cash and settles the debt.

Agreeing what counts as normal working capital, and how it will be measured, is one of the most valuable pieces of preparation a buyer can do before heads of terms are signed.