Deferred Payments: the question that should be on every seller’s lips

Introduction

Selling an asset, whether it’s shares, property or part (or all) of a business can be an exciting but complex process.

And how you structure the purchase price payable to you will be a key consideration.

But if you intend to allow payment of all or any part of your purchase price to be deferred until after the sale date, there is one critical question you should always ask well ahead of signing the sale contract.

Miss it, and the consequences could be more than just inconvenient.

Stephan Smoktunowicz, Banking & Finance Partner, explores why this question is so important and why you should ask it upfront.

Deferring payment and the purchaser’s ability to pay

Deferred consideration on an asset sale can be structured in many ways. For example:

• a specified amount payable on a date after the sale is completed (e.g. £2,000,000 on 31 March 2030); or

• a payment based on defined parameters (e.g. a slice of net profits of the sold business achieved above a specified figure within a set period).

Allowing the purchaser to defer payment of some or all of the total purchase price may make sense to a seller for various commercial or accounting reasons. However, whether the seller ultimately receives that deferred payment will boil down to not only whether the purchaser has the cash to pay the seller, but just as crucially, whether the purchaser is even allowed to pay you.

Before you agree to any deferred payments, you should always assess any associated risks which poses the following important question.

Has the purchaser granted security or is it intending to do so?

This question is of vital importance to all sellers considering taking any deferred payment for two main reasons.

1.       Cash restrictions

A disposal of cash by the purchaser (including making a deferred payment) could be prohibited under the terms of a security document (e.g. a debenture or charge).

If so, the purchaser cannot make payment to the seller without the security holder agreeing to that.

2.       Dilutionary impact

If the purchaser has already granted security which remains outstanding or it intends to do so, it is likely to be indebted to the security holder.

Depending on the terms of the security, the security holder may also hold the benefit of the security for other creditors of the purchaser.

If the purchaser subsequently faces financial difficulties or becomes insolvent, the security holder may look to its security to realise value and recover the secured debt, which could leave insufficient monies to pay the seller all or any of its deferred payment.

Furthermore, if a secured creditor is not restricted from increasing its day-one debt levels, this could further dilute the seller’s position.

Why is it important to ask this question at the earliest opportunity?

Sellers should consider raising this question as early as possible in the sale process on the following grounds.

1.       Early risk assessment

It allows the seller to make an initial assessment of what purchaser security will be in place and the associated risks of including deferred payment within the purchase price structure at the earliest opportunity and if necessary, to take advice on whether any identified risk can be mitigated.

2.       Assumptions

It reduces the risk of the seller making incorrect assumptions about factors that may affect the purchaser’s ability to make deferred payment down the line.

3.       Costs and delays

It mitigates the risk of the seller incurring unanticipated costs and delays which would otherwise arise if the seller were to find out about the security at the last minute.

It also allows the cost and time of assessing the security and putting in place any necessary arrangements to be factored into transaction costs and timetable at the outset (e.g. an intercreditor agreement to which the seller, the security holder and the purchaser are parties, allowing for payment of deferred consideration in agreed circumstances).

Plan ahead

When planning a transaction, it can be tempting for a seller to avoid asking too many “technical” questions early on, but ignoring these details at the outset can be a costly mistake. The earlier the question of purchaser security is raised, the earlier the areas of risk can be assessed.

Ultimately, working through those risks and agreeing parameters with secured creditors to allow the disbursement of deferred payments will come down to negotiation and the bargaining strength of the parties, but giving thought to this at the earliest opportunity does at the very least allow a seller to reduce any last-minute shocks to the system.

If you would like to discuss any of the matters raised in this article or to find out more about Stephan’s practice, contact Stephan here.