When You Sell - Cash or Equity?

In our article on Common Deal Structures, we talked mostly about cash transactions, but there are certainly times when the best structure for both the buyer and the seller is stock or another form of equity.

Essentially what we’re referring to is a deal structure where the stock or assets of the seller are transferred to the buyer in return for stock in the buyer’s company.

To the buyer, this structure offers several important benefits, as well as some downside considerations:

Pros

o   It preserves cash.

o   It avoids the need for a loan which can impact creditworthiness or be governed by existing restrictive covenants.

o   It can motivate the seller to remain involved in the business since there is a potential “upside”.

Cons

o   It dilutes stock.

o   It may keep the seller involved when the desired strategy is otherwise.

To the seller, the pros and cons of an equity structure include:

Pros

o   It generally comes with a higher overall valuation, but that valuation could be based on overinflated stock value.

o   Gives an upside opportunity if the buyer’s business grows.

o   May provide a tax deferral benefit.  (Obviously a tax professional should always be a part of the transaction team).

Cons

o   The valuation may be based on an overinflated stock value.

o   The seller becomes a minority owner and has to deal with difficult adaptive changes.

o   The buyer’s business may actually decline, in which case the stock (or other equity instruments) used to pay for the sale decrease in value.

Even if financing or payment terms are a part of the deal, a cash transaction can be much more straightforward, with the seller’s “payoff” being understood at the time of closing.  Cash deals can also be structured to have an upside without the risks of the stock price contingencies of an equity structure.

It’s important to note that equity transactions really only apply to strategic buyers like other agencies or companies in related industries.  Financial buyers, like private equity firms, are generally only interested in buying for cash.

Whether by cash or equity, financing a sale is a complicated undertaking that requires extensive planning by the buyer, the seller and their respective teams of legal and financial experts.  And like valuations, the most successful approach is the one that best meets the needs of both the seller and the buyer.