Bridging the Gap: Seller Financing Options in M&A Transactions
In today’s deal environment, where interest rates remain high and access to credit is tight, seller financing is increasingly being used as a tool to move transactions forward.
In today’s deal environment, where interest rates remain high and access to credit is tight, seller financing is increasingly being used as a tool to move transactions forward. It helps bridge valuation gaps when buyers and sellers disagree on price; expands the pool of qualified buyers who may have limited upfront capital; and offers sellers the potential for future upside through deferred payments or equity participation. Ultimately, seller financing can help expedite deal completion while aligning both parties’ long-term interests.
What Is Seller Financing?
Seller financing occurs when the seller of a business agrees to finance a portion of the purchase price, typically through a promissory note, installment payments or convertible equity, rather than requiring full cash payment at closing. This structure allows buyers to complete acquisitions without relying entirely on third-party debt or equity funding.
Top Seller Financing Structures
There are several flexible financing structures that allow buyers and sellers to bridge valuation gaps, share in future performance or provide financing support. Each option has its own risk profile, complexity and practical considerations.
Common seller financing structures, including:
- Seller Notes or Promissory Notes: The seller extends a loan to the buyer, repaid over time with interest. This is a simple, flexible option that maintains pricing tension, but carries credit risk if the buyer underperforms. This option is typically used to bridge valuation gaps and in smaller deals.
- Earn-Outs: A portion of the purchase price is contingent on future performance (e.g., revenue or EBITDA targets). This aligns incentives and bridges valuation gaps, but can be complex to negotiate and prone to disputes over performance metrics. This structure is often used in growth or turnaround situations and to bridge optimistic projections.
- Equity Rollovers: The seller retains a minority stake in the new entity, signaling confidence and sharing in future upside. However, this can introduce illiquidity and governance complexities. This option is usually selected in sponsor deals or to achieve alignment among management.
- Contingent Value Rights (CVRs): The seller receives additional payments tied to specific milestones, such as regulatory approval or a product launch. These are useful in specialized situations, but require precise drafting and monitoring. This structure is commonly used in the healthcare and technology sectors around regulatory milestones or product launches.
- Preferred Equity / Seller ‘Stub’ Equity: The seller receives preferred shares or structured equity in the buyer or new company. This hybrid of debt and equity ensures payment priority but can come with subordination risk and limited liquidity. This option is often selected when PE sponsor continuation is necessary.
Practical Tips for Sellers
- Evaluate buyers’ repayment capacity. Conduct financial due diligence on the buyer’s ability to meet payment obligations, including cash flow forecasts and existing leverage.
- Document metrics, reporting and dispute resolution clearly. Clearly define performance metrics, reporting requirements and dispute resolution mechanisms to reduce ambiguity and litigation risk.
- Use collateral / escrow to protect downside. Secure seller notes with collateral, guarantees or escrowed funds to mitigate credit exposure and ensure recovery in the event of default.
- Model tax impacts of deferred / contingent payments. Deferred and contingent payments can have significant tax consequences. Work with advisors to model cash flow, recognition timing and potential deferral opportunities.
- Plan for post-closing oversight. Establish protocols for financial reporting and performance verification, especially for earn-outs or milestone-based payments, to maintain transparency and accountability.
Agile Legal Helps You Select the Best Financing Structure
Seller financing offers tremendous flexibility, but also introduces legal, tax and operational complexities that must be carefully managed.
Agile Legal helps clients navigate every step of the process, including:
- Deal structuring: Advising on the optimal seller financing mechanism to achieve valuation goals while managing risk.
- Contract drafting and negotiation: Ensuring key terms, triggers and repayment provisions are clearly documented and enforceable.
- Due Diligence and compliance: Reviewing buyer financials, collateral and legal structures to safeguard seller interests.
- Tax and regulatory coordination: Collaborating with tax and financial advisors to align structures with jurisdictional requirements.
- Post-Closing management: Supporting clients with monitoring, enforcement and adjustments as performance milestones are met.
Seller Financing Simplified
Seller financing is more than a creative payment mechanism; it’s a strategic tool for closing deals. Agile Legal helps clients evaluate and structure seller-financed transactions that balance opportunity with risk, ensuring documentation, compliance and execution are aligned across the deal lifecycle.
Need help identifying the best seller financing option for your deal? Contact us to learn how we help structure, negotiate and manage seller-financed transactions that drive growth and success.
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