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Deferred Consideration - Worth the Paper? 9 June 2011

Recently, business commentators have spent a lot of time scratching their heads to identify common trends in the Scottish deal market aside from (with a few exceptions) a massive senior-lender-shaped hole in the funding market.

Like the changing line up of American X Factor Judges, it's difficult to identify a pattern or make a forecast.

However, one trend we have identified in the course of the last few years is the increasing prevalence of deferred consideration in the acquisition and disposal of businesses.

Deferred consideration has massive benefits for the purchaser. Invariably there will be a payment up front with the back end taking the form of either equity in the acquiring company (quite common if a PLC is the purchaser) but more often than not a promise to pay cash dependent upon:

- the passing of time (i.e. a fixed payment schedule);

- the achievement of profit targets;

- the achievement of turnover targets; or

- some other performance based measure such as the winning of a particular sales contract.

Of course this allows the purchaser to defer the acquisition cost (and usually make savings when compared with the cost of traditional forms of borrowing).

For the vendor however, the deferred consideration route is fraught with danger and needs to be approached very carefully indeed.

We would always recommend that a vendor seek either a bank guarantee or alternatively (and more likely) a personal guarantee from either the owner managers of the purchaser or a related group company which has a proven covenant and balance sheet. The vendor should be made well aware of any set off rights which are very often well disguised in the context of a large purchase document and which can give the purchaser carte blanche to hold back cash if it claims that a warranty or indemnity in the purchase document has been breached following completion of the deal.

There are sensible compromises we can suggest to allow the vendor to exercise some control on the purchaser's right of set off, and indeed some control over the purchaser's running of the target business during the deferred pay out period, but for the vendor the aim must be to secure as much money as possible up front in the initial deal negotiations - sometimes even at the cost of accepting a reduced price for the business.

If you would like any further information on the matters above, please contact David Beveridge or Philip Hannay.

Last updated: 4.27pm, Tuesday 1st May 2012

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