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Anatomy of a deal

John Wagner - Acquisition offers

There can be as many as four deal elements that make up an offer to acquire your company. As an indication of interest (IOI) or a letter of intent (LOI) is presented by the acquirer, they will lay out a proposed structure for the deal using these elements, which are 1) cash at closing, 2) an earn-out, 3) a seller’s note, and 4) “rolled shares.” When an acquirer includes any of these deal elements in their offer, it affects the amount of cold hard cash the acquirer must pony up to close the deal.

As we look at these deal elements, note that the “cash at close” portion of the deal can itself be broken down into i.) cash from the acquirer, and money the acquirer borrows, typically in the form of ii.) senior debt, and iii.) subordinate debt.

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Ok, let’s say you sell your company for $20 million. An acquirer may offer all cash at close, and that’s the best possible deal structure for sellers, by far, since it takes the seller’s risk entirely off the table. As a seller’s rep, our investment bank has a strong bias for all-cash deals.

That said, to reduce how much cash the acquirer commits to the deal, they may offer just $15 million in cash of the total $20 million purchase price. Then they may reduce demands on their “dry powder” (cash) by putting deal element #2 in place, an earn-out.

Let’s say the acquirer agrees to pay you $3 million of the $20 million purchase price one year after the acquisition, if you “earn-out” by achieving pre-set growth and performance metrics.

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Now, of the $20 million the acquirer offered, they are ponying up $15 million in cash, and deferring $3 million for a year. That gives them breathing room to pay for part of the acquisition out of the future proceeds of the very company they are acquiring.

However, $20 million—$15 million (cash)—$3 million (earn-out) still leaves $2 million to be made up. Of that outstanding $2 million needed to close the deal, the acquirer may ask that deal element #3 be used, proposing that

$1.5 million in deal value be represented by a seller’s note. That’s where you, the seller, loan the acquirer some money to buy your own company.

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(These notes are typically 5-year terms at 7%, interest only; balloon paid on the fifth anniversary. It’s unsecured debt, hence the high interest rate to compensate for that risk.)

Ok, the acquirer has almost all the money needed to close the deal. For the $20 million value, they are putting up $15 million, you are earning-out $3 million, and they are borrowing $1.5 million from you as well.

Now, where does the last $500,000 come from? The acquirer may bring in deal element #4 and offer $500,000 of the deal value in rolled shares, where you, the seller, take shares in the NewCo created by the acquisition (or take equity in the existing company the seller is now joining). That $500,000 can be quite valuable, with patience. However, for you to get this “second bite at the apple,” and redeem those shares, you must wait for the NewCo to grow and have a liquidity event where your shares can be redeemed. (Typically, rolled shares are not initially liquid.)

The table below shows the deal elements in action. Note that I have broken out the buyer’s $15 million into three categories: cash, senior debt, and subordinate debt, using proportions that are common today. (These proportions change with borrowing costs.) Note that deal elements #2, #3, and #4 are collectively referred to as “seller leverage.”

wagner chart

Now we see the full range of deal elements employed in composing the deal, all of which are negotiable, including which elements are included and what proportion of the deal they represent…and that’s where your investment banker’s advice is invaluable.

John Wagner is a managing director at 1stWest Mergers & Acquisitions, which offers a specialty practice in the LBM sector. Reach John at

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