Commonly used deferred consideration mechanisms
The reliance on deferred consideration in the secondary market is an evolving trend and as such, there is currently no market standard approach. Interestingly this is something of a 'back to the future' moment. A significant number of early secondary deals, especially sale of bank portfolios, were vendor financed. As fund level financing became more sophisticated, available vendor financing almost disappeared. But, in recent times, it has had something of a resurgence. Similarly to M&A transactions, there are multiple ways to use deferred consideration in secondary transactions. Some of the more commonly used mechanisms include: (i) performance based earnouts; and (ii) loan notes.
When secondary transactions are subject to earnout requirements, a portion of the consideration is paid on completion and following this, additional amounts will be due and payable if the negotiated milestones (for example, hurdle rates) are met, as indicated in the structure charts above. The market has seen an increased use of earnouts over traditional escrow structures.
When incorporating loan notes as a form of deferred consideration, a portion of the consideration is paid on completion. The seller then accepts loan notes from the buyer for the outstanding consideration and effectively becomes a creditor of the buyer until such loan notes are settled.
