Predator Alert: Spotting Red Flags in a $50M LOI
Selling your business is a major milestone, and the deal structure can significantly impact your outcome. Don’t let complex terms jeopardize your financial future. Work with experienced advisors who can help you navigate offers, spot red flags, and ensure you walk away with fair value.
Understanding Predatory Deal Structures in M&A: How to Spot and Avoid Them
When selling a business, it’s easy to be lured by offers that seem attractive on the surface but contain complex structures that put sellers at a significant disadvantage. In this video, Kirk breaks down a recent Letter of Intent (LOI) that highlights how some buyers use excessive deal structures to shift risk to the seller while retaining control of the business.
Key Takeaways from the Video
Beware of Over-Structured Deals:
Deals with multiple layers—such as rolled equity, earnouts, and deferred payments—can dilute the true value of your transaction. In the example discussed, a $50 million transaction promised a combination of cash, stock, and earnout payments. However, the upfront cash was significantly less than advertised, leaving the seller bearing much of the risk.
The Danger of Earnouts Based on Aggressive Forecasts:
Earnouts tied to overly optimistic growth projections can leave sellers chasing uncertain payouts. In this case, 20% of the deal’s value depended on achieving a 15% EBITDA growth—based on the buyer’s quick extrapolation of the seller’s pipeline, not a realistic analysis.
Synergy Clauses Can Be Vague and Risky:
Some deals condition payments on undefined “synergy benefits,” which can be hard to quantify and often serve as an excuse to withhold future payments. Sellers should be wary of ambiguous terms that leave room for manipulation.
Risk Transfer Without Control:
The buyer in this scenario retained control of the business while deferring much of the payment. This means the seller’s payout depended on decisions they no longer had influence over—a dangerous position.
Protect Yourself: Pause, Review, and Negotiate:
If a deal seems overly complicated or “too good to be true,” it probably is. Sellers should seek professional advice, push back on unreasonable structures, and focus on securing guaranteed cash at closing.
Important Terms to Know:
Letter of Intent (LOI): A preliminary agreement outlining the basic terms of a potential deal. While non-binding, it sets the stage for negotiations.
Earnout: A payment structure where part of the purchase price is contingent on the business meeting future performance goals.
Rolled Equity: When sellers retain a minority stake in the newly formed company post-transaction.
Synergy Benefits: Cost savings or revenue enhancements expected from combining two companies, often cited as a reason to justify deferred payments.
