Newport Capital - M&A Deal Structures Explained

Founded in 1989 – Newport Capital is Australia's leading and longest-established licensed strategic advisory and M&A Investment Banking firm.

In investment banking, deal structures refer to the specific financial arrangements and terms negotiated during company acquisitions or mergers. These structures can include various components, such as contingent payments and earnouts, to manage risk and align the interests of buyers and sellers.

Here’s an overview:

1. Contingent Payments

Contingent payments are part of a deal where a portion of the payment is dependent on future events or milestones. The buyer might agree to pay a certain amount upfront and the remainder if specific conditions are met after the deal closes. This approach is often used to mitigate risk, particularly in cases where the buyer is uncertain about future business performance.

Examples of Contingent Payments:

• Performance-Based Payments: The buyer commits to paying additional amounts if the acquired company meets certain revenue or profit targets over a set period, typically 1-3 years.
• Milestone Payments: Payments are tied to the achievement of specific business goals, like launching a new product or entering a new market.

2. Earnouts

Earnouts are a type of contingent payment specifically tied to the target company's future performance. They allow the buyer to reduce risk by linking part of the acquisition price to the company's post-acquisition success. Sellers often prefer earnouts because they provide them the opportunity to earn more if the business performs well under new ownership.

Key Characteristics of Earnouts:

• Revenue or Profit-Based: Earnouts are frequently tied to future revenue or profit performance. For example, if the company achieves $10M in annual revenue, the seller receives an additional payout.
• Timeframe: Earnouts typically last 1-3 years, giving time to evaluate the acquired company's performance under the new owner.
• Caps: Sometimes, earnouts are capped to limit the buyer's potential payout.

3. Deferred Payments

In a deferred payment structure, a portion of the purchase price is paid at a later date, regardless of performance. This can be appealing if the buyer wishes to spread out their financial obligations over time, or if financing is contingent on future capital availability.

Example of a Deferred Payment:

• Total Transaction Value is $70M.
• The buyer agrees to pay $50M upfront and an additional $20M after two years without any performance conditions.

4. Escrow Accounts

In some deals, part of the purchase price is placed into an escrow account, which can be used to cover any claims or indemnities (like undisclosed liabilities) that may arise after the transaction closes. This protects the buyer from unforeseen risks.

Example of an Escrow Payment:

• The buyer places 10% of the purchase price in an escrow account, which will be released to the seller after a 12-month period, assuming no claims or issues are raised.

5. Earnouts vs. Contingent Payments

While both earnouts and contingent payments link parts of the purchase price to future events, earnouts are more specific to company performance (e.g., revenue and profit targets), whereas contingent payments could be tied to other milestones, such as regulatory approvals or product development.

Benefits and Risks:

• Benefits for Buyers: Reduces upfront payment risk and ensures the company performs as expected before paying full value.
• Benefits for Sellers: Offers potential to receive a higher total payout based on future success, and aligns interests with the buyer.
• Risks for Buyers: Earnouts can create disagreements about financial reporting or operational decisions that affect the seller's payout.
• Risks for Sellers: May receive less than anticipated if performance targets are not met, especially if external factors (like market conditions) affect outcomes.

In summary, contingent payments and earnouts allow buyers to structure deals that share risk between both parties, incentivising the seller to ensure the business's ongoing success while managing the buyer's risk in uncertain conditions.

To bridge the gap between an incoming acquirer and the seller, earnouts are frequently used in M&A transactions. Newport Capital has extensive experience in negotiating premium outcomes for our clients, primarily through effective deal structuring.

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Since 1989, Newport Capital has successfully executed hundreds of client engagements. Our clients range from privately owned rising stars to ASX-listed companies and major global vendor organisations.

Newport Capital’s industry focus and core knowledge base is across the TMET (Telecommunications, Media, Entertainment & Technology) sector.

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