One illustrative sale taken from the announced price to the cash in the seller's account, and then to what the later consideration is worth today.
Start from enterprise value, not the headline, deduct net debt and debt-like items, adjust for working capital, then take off what is held back, paid later and paid to advisers. On an illustrative deal announced at EUR 110.0 million, the seller receives 61.1 million in cash at completion, 55.5 per cent of the headline. Counting what arrives later at its expected value and discounting it at 8 per cent, the whole consideration is worth 78.61 million.
Worked in full in Closing the Deal by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
A founder-owned business is sold for an enterprise value of 100.0 million plus an earn-out of up to 10.0 million over two years, announced as "up to 110.0 million". The buyer uses completion accounts, a price adjustment escrow, a warranty escrow and a deferred payment. Every figure is illustrative and stated before the seller's tax.
Price at completion = EV − debt + cash − debt-like items ± (estimated working capital − peg)
= 100.0 − 22.0 + 5.0 − 3.0 − 0.8 = 79.2
The equity value is 80.0, and the estimated working capital at completion is 0.8 below the peg. The earn-out is not in this figure at all: it is contingent, and the 10.0 million is a ceiling. The debt-like items are where most bridges are fought, worth a whole article on their own: how much disputed debt-like items move the price.
| Line | Amount | When it is received |
|---|---|---|
| Headline, including the full earn-out | 110.0 | |
| Less earn-out, contingent | −10.0 | Year 2, if earned |
| Enterprise value | 100.0 | |
| Less debt repaid at completion | −22.0 | |
| Plus cash in the business | 5.0 | |
| Less debt-like items | −3.0 | |
| Working capital below the peg, estimated | −0.8 | |
| Price for the shares at completion | 79.2 | |
| Price adjustment escrow | −1.5 | After the completion accounts, about 6 months |
| Warranty escrow, 10% of equity value | −8.0 | 18 months, less claims |
| Deferred consideration | −5.0 | 12 months |
| M&A adviser, 1.5% of EV | −1.5 | Never |
| Lawyers and vendor due diligence | −0.9 | Never |
| Management transaction bonus | −1.2 | Never |
| Cash at completion | 61.1 |
Of the 79.2 million price, 14.5 million is held back or deferred and 3.6 million goes to costs. The seller banks 61.1 million on the day: 55.5 per cent of the headline, 61.1 per cent of the enterprise value and 76.4 per cent of the equity value.
The held-back amounts are not lost, but they are not cash either. Each is valued at the amount the seller expects to receive, discounted from the date it is expected, at an illustrative 8 per cent.
PV = expected amount / (1 + 8%)years
Warranty escrow: 7.6 / 1.081.5 = 6.77
| Item | Maximum | Expected | Years | Present value |
|---|---|---|---|---|
| Price adjustment escrow | 1.5 | 1.0 | 0.5 | 0.96 |
| Warranty escrow | 8.0 | 7.6 | 1.5 | 6.77 |
| Deferred consideration | 5.0 | 5.0 | 1.0 | 4.63 |
| Earn-out | 10.0 | 6.0 | 2.0 | 5.14 |
| Total | 24.5 | 19.6 | 17.51 |
The expected earn-out of 6.0 is an assumption, and the largest one. How an earn-out's shape and the buyer's accounting change that number is worked in earn-out cliff vs straight line.
Cash at completion of 61.1 plus later consideration worth 17.51 gives 78.61 million: 71.5 per cent of the 110.0 million headline. The gap of 31.39 million has four parts. Net debt and debt-like items, 20.0, are not the seller's to begin with; they were always going to be paid out of the enterprise value. The earn-out's expected shortfall and discounting take 4.86. Costs take 3.6. The rest is working capital, expected escrow claims and the time value of the held-back money. Only the first part is visible in the announcement.
The maximum the seller can ever receive is 85.6 million: the 79.2 price, less 3.6 of costs, plus the full 10.0 earn-out. A seller who plans its next step on 110.0 is planning on money that does not exist in any scenario.
| Earn-out paid | At 6% | At 8% | At 12% | % of headline at 8% |
|---|---|---|---|---|
| None | 73.75 | 73.46 | 72.92 | 66.8% |
| 6.0 of 10.0 | 79.09 | 78.61 | 77.70 | 71.5% |
| 10.0 in full | 82.65 | 82.04 | 80.89 | 74.6% |
Even with the earn-out paid in full, the seller's consideration is worth 74.6 per cent of the headline at 8 per cent. The earn-out outcome moves the total by 8.57 million between nothing and everything; moving the discount rate from 6 to 12 per cent moves it by 1.39 at the expected earn-out. What the seller should negotiate hardest is what reaches completion, not the ceiling.
The bridge, the peg, the two completion mechanisms and the earn-out are all live in the free workbooks for this book.
The headline usually includes contingent consideration and is quoted before net debt. Cash at completion is the equity price after debt, debt-like items and the working capital adjustment, less escrows, deferred payments and costs. In the worked case a 110.0 million headline becomes a 79.2 million price for the shares and 61.1 million of cash on the day.
It depends on the protection the buyer wants. In the worked case a price adjustment escrow of 1.5 million covers the completion accounts true-up and a warranty escrow of 10 per cent of the 80.0 million equity value, 8.0 million, covers claims for 18 months. Together they are 9.5 million, 12.0 per cent of the price. W&I insurance can replace most of the warranty escrow.
No. Value it at the expected payment, discounted from the date it is due. A 10.0 million earn-out expected to pay 6.0 in two years is worth 5.14 at 8 per cent. Between paying nothing and paying in full, the total consideration in the worked case moves from 73.46 to 82.04 million, so the earn-out assumption should be stated, not buried.
This article is one calculation from Closing the Deal. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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