Current Trends
Most of the current trends in doing a deal relate to the structure of the financing of an acquisition. It is not necessary to pay all cash to buy a business, and if you do pay all cash you may be able to negotiate a cash discount. The structure of a transaction is your opportunity to get creative.

Taxes, who pays them and how much, is often an opportunity to negotiate. Be sure to go to the table armed with a creative financial advisor.

What is an Earnout?
One transaction financing structure includes a form of royalty payments, sometimes called an earnout, based upon company sales or profits. Operating under the belief that the value of a business is based upon its future earnings potential, an earnout often helps negotiate value gap between the buyer and the seller. It can also improve the transition of business ownership by keeping key people around for two to five years, the typical length of the earn-out arrangement.

There are limitless ways to structure earnouts, in part because of the factors unique to each deal. It is a complex agreement, best drafted by experts. And, it involves a higher level of trust and rapport between the buyer and seller of a business so it may not be appropriate for everyone.

Earnout agreements often open the door to ethical dilemma. Sound business decisions to cut expenses or expand the business are often inappropriately weighed against the liability to pay on an earnout contract. In a well-drafted earnout agreement, these situations are accounted for.

Buyers' express concern over their obligation to make larger payments than anticipated if the acquired company has erratic earnings. This can be addressed in the earnout agreement with payment floor and ceiling amounts. Buyers are also concerned that they will pay the earnout even if earnings improve because of their hard work rather than because of any impending growth present at the time of acquisition.

Sellers' on the other hand express concern over the management ability of the buyer and their lack of control over the business decisions subsequent to the sale. The methods and accuracy of accounting for earnings is also a perceived trouble area that must be addressed in the earnout agreement. Formulae to calculate contingent payments often represent a percentage of sales or gross profit in order to minimize concerns over expense decisions and reporting.

I rarely see it but the agreement should include ways to undo the earnout arrangement if the deal doesn't seem to be working out.

What is a LBO?
Leveraged Buy Out was a popular term in the 80's. In a bare-bones LBO, the buyers form a corporation that raises the funds to purchase a target corporation, the target may be totally merged into the new corporation. Alternatively, the target is then liquidated and all of the assets and liabilities are transferred to the new corporation or the buyers may choose to operate the target as a subsidiary of the new corporation.

The new corporation uses the target's assets and cash flow as collateral for large, long-term loans to finance the purchase and operation of the acquisition.

The strategy used is to direct enough of the corporation's cash flow to relieve the debt burden, but still provide operating funds. As recent history tells us, a slight downturn in the business can require the company to seek bankruptcy protection from this new debt in order to continue operations.

What's A Convertible Debenture?
A close relative to earnout arrangements is the deal involving debt that can be converted to common stock of the acquiring company known as Convertible Debentures.

Like the earnout arrangement, shareholders of the acquired company have an opportunity to share in the future profits of the company by converting their debenture into common stock.

One of the attractions to convertible debentures is that the acquiring company gets a tax deduction for interest paid on the debentures. There are limitations imposed on interest payment deductions exceeding $5 million when the indebtedness is consideration for two-thirds of the non-cash operating assets of the business.

Be aware that the IRS may consider these debentures a second class of stock which is not allowed for subchapter S corporations.

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