From deal to price

Once a seller has made a "deal" with a buyer, the thought is often that exactly the agreed amount (sales price) will also be credited to the bank account at the time of transfer. This is by no means always the case! There can be several reasons for this. Sometimes legitimate and sometimes (too) far-fetched reasons. In this article we will elaborate on the process from deal to price and provide tips about different aspects where you should pay close attention to, because mistakes quickly have far-reaching consequences.

Between letter of intent and acquisition agreement

Once the seller is in contact with a suitable buyer and both parties agree on the terms of a business transfer, intentions are recorded in a so-called letter of intent (also called LOI). The letter contains the deal (usually in outline form) that includes the timeline, bid and applicable conditions.

The signing of the LOI is usually also the starting point of the due diligence (the 'DD' also known as 'book examination'). During this investigation, the buyer checks all information shared by the seller and requests additional items that are used to form a picture of the company.

During due diligence, the buyer may run into issues that they want to factor into the agreed upon acquisition price. And the seller on the other hand may still have things to claim (VAT, for example) for the period prior to the effective date of the acquisition. The seller on his/her side will want to bring this back in.

In short: the bid in the LOI is often not exactly the amount paid at the time of transfer. And that can be a major setback at this stage (where often a period of exclusivity has already been discussed with a buyer). We will elaborate in the rest of this article on the usual way to go from a deal to the acquisition price. Here we will assume the situation where a Private Limited Company is being acquired. Even when acquiring just Assets, there may be corrections after due diligence, so the line of thought in this article can be broadly followed for entrepreneurs selling their business through an asset transaction.

Equity bridge

Before we continue, it is first good to have the following concept in mind:

 

The enterprise value is determined with a discounted cash flow calculation or based on a multiple x normalized EBIT(DA). This amount is the offer made by the buyer for your company and on the basis of which the LOI is signed.

In the setting of a business acquisition, adjustments are then proposed based on items designated as cash (like) or debt (like) and based on the amount of working capital at the effective date (where cash and cash like items are added to enterprise value and where debt and debt like items are subtracted from enterprise value to determine share value).

The amount remaining is referred to as the value of the shares (the equity value). This is the amount the buyer must pay the seller for the acquisition (usually an amount payable directly in cash plus an earn-out or seller loan).

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Due diligence

So what are some things that may become apparent during a due diligence that will affect the price paid by the buyer? Depending on the creativity of the parties, many different items can be brought up here. The essence for each item is always that it can be seen as a non-operating asset or debt. This need not necessarily be apparent from the balance sheet, but can also be a liability not apparent from the balance sheet.

Some examples:

  • (Excess) liquidity (cash)
  • Equity portfolio (cash like)
  • Kickback fees receivable (cash like)
  • Overdue maintenance (debt like)
  • Pension deficit (debt like)
  • Interest-bearing debt (debt)
  • Taxes (debt or cash like)
  • Outstanding gift cards (debt like)

In addition, working capital forms part of the adjustments. This looks at the difference between working capital at the effective date and the average monthly working capital for the previous 12 months. The deficit or surplus is presented as an adjustment to the enterprise value.

Discussions about equity bridge

It should come as no surprise that in practice there are many discussions about the calculation of equity value. And that's not surprising, since some of it is downright subjective. There will be agreement on an items such as interest-bearing debt, but on most of the other items people may have different views (with good reason). Whether and how they are then incorporated as corrections is then mostly a matter of negotiation.


And that can be a setback. The seller assumes to have agreed on a price in the LOI, and there are buyers who make a sport of negotiating the price substantially in a second round after due diligence. The seller's position is then less strong because an exclusive period is usually agreed upon in the LOI and other interested parties are put 'on hold'.

Development of an equity bridge

After reading the above explanation, you are probably curious about the effect of such an equity bridge. This obviously differs per acquisition and not every buyer, seller or acquisition advisor will have an identical approach. See the calculation below as an example of what an equity bridge can look like:

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