This is where the vendor has to play his part and step in as the “balancing figure”.
Deferred consideration is becoming an increasingly common component of the funding structure in today’s Management Buy Outs. The vendor’s realise that by helping the MBO team is often the only way a deal can be done.
Indeed, many 3rd party loan providers may well insist that the vendor “stays in” with deferred consideration in order for them to show continued support in the business.
The deferred consideration is the element of funding that is “deferred” in repayment behind other loans. Quite often we see Management Buy Out’s where the deferred is paid down in multiple tranches as the MBO team return to the senior debt provider once debt is paid off. This can be 2 or 3 times.
The terms of the deferred consideration vary from deal to deal, this is in respect of interest, security (if any), obligations to buy back shares, term repayment or bullet repayment.
In most cases, the deferred consideration ranks behind other lenders in the security “pecking order”
An earn out is where the deferred consideration carries some upside benefit to the vendor.
Additional consideration or a premium is paid if certain financial performance targets are attained. Similarly, the deferred consideration can be limited or reduced if performance targets are not attained.
The “safety net” is often implemented to reduce the price for the MBO team if the consideration was based on future events happening that fail to materialise – large orders, loss of customers, new technology etc.
