How to Bridge Valuation Gaps in M&A

In M&A, it’s very common for buyers and sellers to disagree on the value of the business. If both parties cannot agree on the price, the deal could fall apart. However, there are certain strategies and tools that both parties can use to compromise and be happy during closing. In this interview, John Blair, Partner M&A Attorney at K&L Gates, shares best practices on how to bridge valuation gaps in M&A.

How to Bridge Valuation Gaps in M&A

14 Feb
John Blair
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How to Bridge Valuation Gaps in M&A

How to Bridge Valuation Gaps in M&A

“If people can execute and deliver on these earnout goals, buyers are happy to pay out because they're reaping the successes. The metric achieved means more cash, a stronger balance sheet for the company bought, and ultimately a higher equity value. It's a win-win situation.” - John Blair

In M&A, it’s very common for buyers and sellers to disagree on the value of the business. If both parties cannot agree on the price, the deal could fall apart. However there are certain strategies and tools that both parties can use to compromise and be happy during closing. In this interview, John Blair, Partner M&A Attorney at K&L Gates, shares best practices on how to bridge valuation gaps in M&A.

special guests

John Blair
Partner M&A Attorney at K&L Gates

Hosted by

Kison Patel

Episode Transcript

When to get involved in the M&A Process

The earlier, the better. It depends on the situation. Usually, for a sell-side engagement, if we're involved with either a public company client or a private equity group, we're involved pre Letter of Intent (LOI) to help when the bankers are first engaged. We might be marking up investment banking engagement letters really early in the process before the target or the assets are in flight.

We are helping behind the scenes, prepping a data room, preparing a draft of an auction, draft of a purchase agreement or merger agreement, thinking through the transaction structure at an early phase. The earlier, the better, because we can add value in terms of the commercial guidance and work alongside the other advisors, whether that's tax or investment bankers, to provide the best outcomes for our clients.

On the buy side, if you are looking at a proprietary deal, during the LOI phase is fine. Sometimes we've been pulled in after, and in those cases, we can't add as much value because the terms are pretty much cemented. Even though it's a non-binding LOI, people try to adhere to the LOI as much as possible.

But a lot of times, groups or companies put in an LOI and they haven't done any diligence, and issues emerge that need to be addressed or risks need to be allocated. Even post LOI, lawyers and transaction advisors can add significant value. However, there are certain choice points that have already been decided if the ink is dry on the LOI paperwork.

Negotiations during LOI

Our involvement depends. Obviously, we represent both buyers and sellers, advocating for our clients in those circumstances. If you're on the sell side and there are a number of offers on the table, it's about extracting the best terms. 

Not necessarily pivoting or juxtapositioning different offers against one another and playing them off, but ensuring the totality of the package works for the exiting shareholders or perhaps the rolling shareholders in some respects, and fine-tuning some of those asks, whether it's economic or corporate governance, or maybe an earn-out.

There are a lot of factors that go into it. It's not always the best cash price. It might be the best overall package for the decision maker.

On the buy side, a lot goes into our clients' letters of intent in terms of describing their investment thesis and how they can add value to the target company.

There's a bit of advocacy. The lawyers make sure the language aligns with what they're trying to do, whether that's describing a rep and warranty insurance policy and the package being made available to the sellers and why that's beneficial to the sellers because it's delivering more cash proceeds at closing.

But there's that trained legal eye and knowledge of the business goals that can help craft a better work product, a better LOI that will set your bid apart. We're not always delivering additional value in terms of transaction proceeds, but we think about how sellers will react to the message. 

It's an independent reader that doesn't come from that particular shop, whether that's a private equity group or an investment professional. So when I'm on that side, I try to think about how the seller will interpret this. Is that a differentiator? Why should they select you? And just thinking through that for clients, is that a competitive advantage you want to highlight, or is it a disadvantage?

And if there is a disadvantage with respect to your bid, how can it be mitigated? Those are the questions that eventually the bankers will be asking, or perhaps the sellers themselves.

Bridging gaps in M&A valuation

There are a lot of tools in the toolkit, and I'm happy to talk about several of them. A few of the structures for bridging the valuation gap include earnouts, which I mentioned before, seller financing like a seller note or seller rollover equity, and equity structures where sellers step into part of the capital structure or third-party participants provide a preferred equity structure.

This is akin to a mezzanine note that is equity but functions like debt in terms of its return, sitting above the common equity return. This allows buyers to stretch in terms of meeting those valuation gaps.

We are seeing a lot of continuation funds. This isn't necessarily bridging the valuation gap but more about private equity buyers saying the valuation isn't good enough right now for a particular asset, so they throw it into a special purpose vehicle and continue to own it for the next three to seven years, then sell it when conditions are right. 

This is adjacent to bridging a valuation gap between buyer and seller, allowing private equity groups to monetize some of their investment but not exit it completely, planning to exit completely down the road in three to five years.

Using holdbacks to bridge M&A valuation gaps 

Holdbacks function like escrows, whether a third party is holding the money or the buyer. We've seen it both ways. Some public company clients, when we're on the sell side, never use escrows because they're creditworthy and in the Dow, so they'll write the check when needed. 

For other sellers, and frankly buyers, it's beneficial to put the money in a third-party financial institution to set aside for future claims. However, I don't view this as solving the valuation gap, which is really driven by a mismatch of valuation expectations.   

We've seen a lot of this in 2023. We were coming off a real deal boom in 2020 and 2021, but now we're in a rising rate and inflationary environment. Even though the Fed decided not to raise rates recently, the debt capital markets are more expensive and stretched. Private equity buyers, in particular, are not looking to deploy as much debt capital in terms of stretching further for their valuations.

Sellers are seeing the numbers from two and three years ago as comps and still expecting high multiples in their respective industries. With banks being more tepid, private credit markets being more cautious, and private equity buyers being more risk-averse, ensuring their models work for a base case or even a recession case scenario, a number of factors lead to the valuation mismatch. 

This is why it's a particularly salient topic today. The first half of 2023 was a bit rocky in terms of deal volume and aggregate deal size, but things are improving with the seasons. Volumes are rising, deals are still getting done, but processes are taking longer and people are being more judicious, influenced by the lack of free flow of capital.

People are ensuring it works on the debt financing side, on the equity financing side, and sometimes this comes at the expense of sellers, hence the need to figure out how to bridge those valuation gaps.

Seller financing

Seller note financing can be thought of as a piece of debt or, creatively, on the equity side, where sellers provide an equity slug of financing. Adjacent to this, we've seen third-party institutional asset managers providing a layer of preferred equity that looks and feels like debt, such as a hold-co pick note or a MES piece of subordinated debt with high yield returns. It's equity, but it functions like pure debt, often with negotiated covenants.

These structures have been employed by numerous sponsor groups over the last few years as an alternative to debt, not impacting covenant levels. This equity structure sits in front of the common return that investors have.

I know this might seem like a deep dive for some listeners, wondering why we're discussing private equity and complex structures. However, it's important for listeners, even those on the public or private company side who are investment professionals potentially selling to a private equity buyer, to understand these dynamics.

There are ways you could invest or maintain an investment if you don't get all your cash upfront at the sale. I've seen creative structures where public company institutions take a tranche or stripe of security in the new holdco that the private equity group is setting up.

Understanding how this part of the ecosystem works is crucial, even for those not in the private equity world, to optimize your outcome and enhance your strategy.


Earnouts are fiercely negotiated. Let's talk about a couple of key terms. The economic or commercial terms are critical: the size of the payment, the duration, and what it's measured against.

There are two main types of earnouts: financially driven metrics like revenue or EBITDA, and milestone related or event-driven earnouts. These could be FDA approval or the outcome of certain pending litigation, some third-party event that the company or target may or may not have control over.

Earnouts tend to be more prevalent in life sciences and healthcare deals, particularly around drug discovery. In our experience, we continue to see earnouts used frequently to bridge mismatched valuations, usually with financial metrics, often EBITDA. 

The same EBITDA that the group was buying into is used to measure the target's earnings or earnings potential over the first year after closing, the second year, or sometimes even longer. This provides a mechanism for a payment by the buyer to the seller for the target achieving those financial metrics over that period of time.

Earnouts on intellectual property

Yeah, your example of buying intellectual property is typically aimed at creating a product or expanding outreach. This could be measured off revenue, geographic growth, or tool adoption. In healthcare, milestones like major drug discovery, FDA approval, or being on a Medicare approval reimbursement list are quite popular as third-party validation type metrics.

Ultimately, it's all about driving revenue. It's a matter of whether this contributes to not being paid in full at closing. What is the investment thesis, and what is the seller leaving behind? Can they control that during the measurement period, whether it's one year, three years, or even beyond?

Milestones need to be tied to the investment thesis. It's likely to come up at the LOI phase unless there's some sort of litigation that wasn't known at that phase. If you find out about significant litigation, like a bet-the-company case or an ongoing patent dispute where your company's value could drastically change based on the outcome, then you start considering if an earnout makes sense. 

Sometimes, buyers come back to sellers after discovering such issues and state that the business isn't worth as much as initially thought, or they can't pay the agreed multiple because it wasn't factored into the model and debt payments.

These are difficult conversations that can arise during the process, highlighting the value of the diligence function. It's not just legal diligence; it involves tax, intellectual property, human resources on labor and employment matters, employee benefits, and more. There's a specialty for everything.

Key variables in an earnout

The big commercial aspects are the payment, time frame, and milestones. On the legal side, we consider several items. First are information rights: what information are you getting during the measurement period? Next, we think about the effort standard required of the buyer to achieve the earnout, such as commercially reasonable efforts or best efforts.

The third and probably most important aspect is governance or control rights. This involves what checks the sellers have on the ability of buyers to make decisions regarding the company they just sold. 

This factors into how, during the ownership period under the measurement period that the buyer owns, what credit is there for mergers and acquisitions. Do you have blocks on some of that? Do you have a consent right? This is crucial because it could be accretive or not, and it could significantly impact the earnings potential of the company that was just sold.

The last point, more of a legal one, is on dispute resolution. There's almost always an ability to dispute the earnout, similar to a purchase price adjustment mechanism. Whether it's done through a third-party accounting firm or some sort of arbiter, there's usually a process to dispute those. 

My litigator colleagues would probably say an earnout is just postponing your dispute over what the consideration is at the time of closing. It's a kick-the-can-down-the-road approach, but it can work for both buyers and sellers. The devil's in the details to navigate both the legal and the commercial challenges.

How many end up in litigation? I will estimate it, but let me just throw in my own legal disclaimer. I am a lawyer, but these are my own opinions, not those of K&L Gates or the law firm, and this does not constitute actual legal advice. This is just fodder for our discussion and edification here on M&A Science. 

I would say about a third of these cases end up in disputes like all-out litigation. This isn't from a formal study; it's more of a haphazard guess. I've asked people who conduct big market studies, like the ABA or other third-party outfits, and nobody can give a straight answer.

We know when litigation is in the court system, but not all dispute resolution procedures run through the court. There are arbitration proceedings and good old-fashioned negotiation before it ever gets to that phase, just like in a normal purchase price adjustment mechanic.

There are ways to mitigate litigation risk, like being really clear about the measurement yardsticks. Are we measuring EBITDA, and how are we doing it? Is it the same valuation methodology used by the deal team at the time of closing, and are we running it through that same system?

Is it based on the EBITDA definition in the credit agreement governing the portfolio or platform company's life cycle? These detailed questions should be sorted out on the front end and included in the legal documents.

Other factors matter too. Is the management team staying on to run the business? How lofty are the goalposts? Some earnouts are aspirational, almost wish list items. A more prudent approach might be if the management forecast in your valuation exit scenario is the litmus test. 

If management thinks they can execute on that 10 million of EBITDA in the measurement period, and that's what you're aiming for with the management team there to execute on it, I think that has a greater likelihood of being achieved.

A fair share of earnouts result in sellers feeling disillusioned, believing more money should have come their way. More often than not, disputes arise over interpretation or feelings that the effort standard wasn't met. Ideally, these situations don't end up in litigation and result in a good outcome for all. 

However, the frequency of disputes must be discounted because some earnouts are based on pie-in-the-sky projections that never had a realistic chance of being met. In such cases, there's no point in litigating, as the goals were never achievable in the first place. Hopefully, the consideration at closing was sufficient.

Earnout payment structure

If you're the seller, you want as much closing date consideration as possible. Viewing a large earnout as great might indicate you wanted more closing date proceeds and have made a significant portion of your consideration contingent. This isn't ideal, as you have to earn it.

From the buy side, the goal is to put in minimal cash and take as little risk as possible, avoiding third-party capital. The strategy is to put much of the earnout on the line, keeping some folks on the hook to ensure goals are met.

If people can execute and deliver on these earnout goals, buyers are happy to pay out because they're reaping the successes. The metric achieved means more cash, a stronger balance sheet for the company bought, and ultimately a higher equity value. It's a win-win situation, but it's important to consider debt providers and financing resources. They need to know about these payments and be comfortable with the potential cash outflow.

Regarding the common range of earnouts, you might see about a third of the closing date consideration pushed to the post-closing period. This has been trending up, maybe around 25 percent of enterprise value. For measurement periods, if it's financial, it's usually one to two years, sometimes three. 

For milestone-related or event-driven earnouts, the duration could be much longer, like five to ten years. These have significant upside but require substantial resources and time, especially in healthcare where government and reimbursement rates are involved.

Financially driven metrics are typically one to three years in duration, with a skew towards year one or potentially even 18 months.

Making earnouts successful

Clarity is key. If it's a longer duration, like the commercial development of a drug discovery or patent litigation, information tends to be helpful and quite different from what would be obtained through financial metrics. 

In such cases, you might want a consultation right or some sort of board right, or an ability to talk to management to understand how things are going or the probability of achieving certain milestones.

This consultation right tends to be more helpful than just reading the financial statements. Whereas, if you're being measured off financial statements, off EBITDA or revenue, that sort of normal course information package is perfectly helpful. 

But when it's more bespoke, like in the examples of litigation or commercial development or a patent infringement case, those consultation rights tend to be softer but probably provide more useful information.

When buyers, especially private equity groups, look to partner with management, they tend to back management teams and align with their investment thesis. They might not delve into granular details in initial conversations, but they certainly conduct background checks, referral calls, and sometimes bring in third-party consultancies for evaluations.

They talk to other management teams they've previously worked with or their existing colleagues to understand the direction they're going.

These relationships between management teams and private equity or public company buyers often span years, sometimes longer, either through industry connections or past collaborations. These aren't relationships forged in a single management meeting. They've had numerous conversations over the years, keeping tabs on the companies, which helps develop trust.

For instance, a private equity buyer might express interest in a company that's not yet on the market, hoping to bid when it is up for sale and potentially preempt the process. This strategy might not involve paying a rich premium. 

Private equity groups aim to partner with management teams, using this relationship to gain trust and strategize on taking the business to the next level. This could involve organic growth, new product offerings, scalable software, investing in new roles like CTO or CIO, or even add-on acquisitions.

These conversations, dinners, fireside chats, and networking in industry groups over years forge these relationships and trust. So, while these detailed discussions might not happen early on, they will come up in the course of the relationship.

Structures of seller financing

When a buyer, particularly a private equity group, is looking to capitalize a new platform company, they bring equity capital and debt capital to the table, usually having a stable of private lender relationships or financial institutions. 

In mismatched valuation situations, where the seller wants a certain multiple on their EBITDA and the buyer is reluctant to spend due to expensive financing or concerns about growth trajectory, valuation disconnects arise. 

One way to bridge this is for the seller to provide debt financing in the form of a note that the company or buyer will pay out over time. This is usually subordinated to the senior loan agreement or even the second lien or Mezzanine loan agreement. It's another way to provide additional financing to pay a higher premium. Sellers are usually happy to take this, as they get their cash over time, rather than all at closing.

We've also seen more creative situations where, when a buyer is setting up financing for the holding company, the exiting sellers set up a tranche of security where they're the first money out when the buyer sells the company in the future. 

This might not have any current pay, like a traditional debt product, but it's the first money out at a future exit. This flexibility allows sellers to reap proceeds along the way, either through a typical debt-like payment like a seller note or at some future exit.

In equity structures, it tends not to be cash pay but rather on exit. However, we've seen exotic structures where cash comes back to the seller after a certain return that the buyer has achieved. This can involve splicing the distribution waterfall and the go-forward platform holding company capitalization table. We work with sophisticated tax advisors to ensure we're not falling into any traps.

The third product is when third parties step into a preferred equity structure, which we've seen more frequently in the last two and a half years. With the tightening of credit, institutional asset lenders, life insurance companies, and other sophisticated parties providing private credit solutions have filled the void that might have been served by a MES debt product or a holdco pick note. 

These preferred equity structures have debt-like features but are actually equity. They might have a high coupon, accruing but not cash pay, and are usually the first cash distributions the company makes to pay down this 'debt-like' equity, redeemable in a set number of years.

You're not making any payments against this preferred equity, which is bridging the gap. It's expensive paper, accruing but not impacting the company's cash burn. It accrues like debt but is usually paid in kind, so you're dealing with compound interest.

Interest rates for this product typically range from 12 to 19 percent. It's like a high teen, expensive debt product, but it's dressed as equity. It's preferred equity. This is particularly interesting for those engaged on the sponsor side or institutional Limited Partner (LP) clients using this for private credit solutions.

When we're on the lender side, even though it's preferred equity, we ask if it's more like equity or debt. We inquire about the covenant package. If it were traditional debt, there would be relief or cushions and similar covenants as in the senior documents.

However, in preferred equity structures, the covenant packages vary greatly depending on the industry, the quality of the credit of the target company, its cash flow, and how comfortable you are with it.

There are challenging conversations about remedies in a failure to pay, what happens in an event of default, or if there's a failure to redeem after, say, seven years. There's no traditional foreclosure like with debt or an ability to take over the asset. Lenders and sponsors get comfortable with other methods, like penalty interest rates or leading to a sale or forced process for liquidity.

This product ends up being a sale or forced liquidity process eight times out of ten, or perhaps even more. It's a hybrid product that bridges the valuation gap. It's not a participating preferred equity like in some emerging growth companies. It's just the first money out, a 14 percent piece of paper, which is quite unique.

Traditional terms of seller financing

In terms of the interest rate, you're probably seeing a function of some sort of base rate, like prime, plus a certain percentage. Sometimes it's done cheaper when the sponsor has more leverage, or it's triggered off what the senior loan documents are. For tax reasons in the United States, it needs to have an interest rate over the applicable federal funds rate.

Regarding duration, it's typically floating over fixed. There are instances where fixed works just fine, but as long as it's calculable, measurable, and not overly complicated, people can get comfortable with it floating. In the last three years, with the higher rate environment, there's been a lot of movement to a floating interest rate.

Previously, when the Fed funds rate was low, people were accustomed to a low rate environment, and fixed rates like 5% or 3% were fine. But now, with the Fed raising rates to battle inflation, sellers might not be as comfortable with a fixed rate.

Duration is a commercial point and varies, probably between one to five years. It depends on how much and over what period of time. Some of the negotiated features to consider are whether, in the event of a change of control, it becomes due and accelerated.

Features like this are important for sophisticated sellers or advisors to consider. Sellers generally want as short a duration as possible to get as much of their capital back, and buyers prefer to extend that duration.

Market’s impact on bridging M&A valuation gaps

It's been a quick paradigm shift coming out of COVID, where valuations were at a premium and buyers were looking to deploy capital with a free flow of debt capital markets. However, in the last year and a half or maybe even a bit longer, there's been a rising interest rate environment. Debt capital has become exceedingly more expensive, especially as the Fed tries to control and stomp out inflation.

This shift has led to increased usage of earnouts. There's been more trepidation about the continued growth trajectories of companies. Banks, creditors, and private equity groups are more wary, building in recession case situations, not just because of inflation, but also due to ongoing supply chain and HR issues in attracting and retaining talent.

This has led to less optimism about growth potential, affecting the economy as a whole, not just any one particular company.

Sellers are trying to hang on to comps from 2019 and 2020 that are really high, but there's a disconnect in valuations. This growing gulf is leading to more earnouts, as well as other structures like seller debt financing and seller equity financing. These serve as bridges to see if a deal can move forward with a market clearing price, often involving contingent consideration like earnouts or other pieces, rather than all cash at closing.

In 2023, we're rolling into the fall, and deal volumes have picked up. They're doing better, based on my experience in terms of deal flow, both on platforms and add-ons, and sell sides. This isn't just in Charlotte, but also from what I've read about and what we've seen.

However, it's not the crazy throughput that it was in 2020 and 2021, where resources were so stretched that you couldn't get a Quality of Earnings (Q of E) done, or a rep and warranty provider was unavailable because they were all booked or done for the year.

The volumes are not at those levels now. People are being more judicious with the cash they want to put to work, ensuring it meets their investment thesis and can support the leverage loan multiples they're applying. They might not be putting as much debt on it as before because of how expensive debt has become, as fed rates continue to rise.

Equity structure 

In terms of equity structures, they cross a number of types of entities, including limited partnerships and limited liability companies. These entities offer a lot of flexibility to craft a distribution or payment waterfall that works for all parties. There's probably even more flexibility in these types of entities, with more choice points than in a traditional Delaware corporation, where there are classes of stock like common and preferred stock.

These structures can be done in corporations, but we typically see them in limited partnerships or limited liability companies, where they are a true creature of contract. This allows M&A practitioners to be flexible and customize for each deal.

Many sponsor groups have a preferred common structure and tend to couple it on a one-to-one basis in how they structure deals, a remnant of doing deals through corporations. However, other sponsor groups have a single class of equity, just common. 

When talking about preferred equity as a solution for bridging a valuation gap, we're referring to a super preferred equity that sits above the common return. This is the first in the distribution waterfall to equity holders, and is  usually not paid until there's an exit or a dividend recap.

Investors, whether sellers providing that tranche or third-party institutional asset managers, understand this. We've seen it on larger deals where there's a stretch or a reluctance to take on much debt. It's also been used in regulatory environments where, for certain calculations under government regulations, like in educational institutions, targets can't have too much pure debt. 

This has been a way to provide financing to the target to help it grow while still meeting its debt requirements under applicable regulations. It's employed to meet regulatory tests and bridge valuation gaps.

Stock options

Well, a really great point is considering ways to incentivize your management team to help grow your enterprise, whether it's a public company with an existing compensation package and philosophy or a private equity group. In private company structures, particularly in LLCs or limited partnerships, there is often a class of equity called profits interests. 

These can be issued with a 0 strike price, allowing participation in the future profits of the enterprise at certain inflection points. These often have time-based or performance-based vesting criteria, enabling participation and taking dollars alongside the common equity holders.

These are ways to incentivize management, not necessarily to bridge valuation gaps between buyer and seller at the deal table, but to help grow the enterprise during the hold period. They align the management team with the goals of the equity investors to grow the enterprise, whether through inorganic growth or organic initiatives.

For corporations, there are stock options or stock option plans, restricted stock, phantom stock plans, and stock appreciation awards. Each of these has different tax and corporate features that make sense in various scenarios. They are all designed to align interests to grow the enterprise.

A lot of times, there's an omnibus incentive plan, which offers a menu of types of awards suitable for different situations. It depends on the size of your enterprise, what you already have, and what you can do within the existing framework of your company or company group, or your jurisdiction, as there are different rules between the U.S. and non-U.S. enterprises.

This is where the value of your tax advisors and legal advisors comes in, and we always recommend consulting them early and often.

Minimizing the cash upfront during a sale

In terms of structuring a deal, it's a bit like choosing your own adventure in terms of how far you can push each lever and get them to work together. The goal is to conserve cash outlay. You might table an earnout, proposing to pay additional amounts at the end of year one and year two, subject to meeting or exceeding revenue or EBITDA thresholds. This helps save money upfront.

For example, if the deal is for ten million and you want to put three million in earnout, that leaves seven million. To further reduce the cash outlay, you could get the seller to accept a seller note instead of cash. This could involve paying a million dollars over the first year post-closing, or even five million over the next five years.

However, you will need to pay something at the closing table. The amount and timing of this outlay can be negotiated. If you have 5 million in debt financing, that leaves 2 million.

If the seller stays on and participates in the business, you could amend your organizational documents, like an LLC or an S corp, to include the seller in your equity capital at your future exit. You might offer them 1 million worth of equity in the company, which leaves 1 million in cash needed at the table.

For the remaining 1 million, you could seek third-party financing. The Loan-to-Value (LTV) ratio would depend on several factors, including your current leverage, cash on hand, cash flows, and the cash flows of the business you're acquiring. The banks will have many questions, but you'll want the ratios to play in your favor.

Contents of LOI

A lot of times, where it's captured in the LOI, the buyer presents sources and uses. This includes the headline price and the enterprise value of the business on a cash-free, debt-free basis. 

For example, if it's a 100 million bid on a cash-free, debt-free basis, and the seller had an existing 20 million senior credit facility, it's expected to be paid off, leaving 80 million of net proceeds for distribution. The buyer will pay for the cash on hand but doesn't want to over-equitize for cash, so they actively monitor how much cash is on the books.

In terms of sources and uses, buyers often present their debt financing partners and equity partners, or what they expect in terms of dollars to equal the 100 million dollars of purchase price in the enterprise value example. 

Public company buyers might finance 75 percent in cash and 25 percent in equity, issuing restricted shares from their universal shelf for that 35 percent and paying the rest in cash. A public company buyer might not mention a credit facility, especially if they have an unsecured credit facility due to their creditworthiness.

Sellers will want to know the mix of considerations: is it a cash deal, are they getting stock in it, and how do they feel about the buyer's public company stock? They'll consider whether they have conviction that it will appreciate during their hold period and at what point they can liquidate and monetize it if they don't have that conviction. 

These are considerations when you see in the LOI the sources and uses being brought to the table, and it's important to stress test this a bit.

Advice for first timers

It's important to think about the tax impact of a corporate deal, which is just one piece of the puzzle. At Canal Gates, we work within deal teams, and not every deal is the same in terms of industry, size, speed, and objectives. When the facts change, it's crucial to test some of your assumptions again, including structuring. 

Ensuring the tax advisor is involved is key to avoid any untoward outcomes that create a bad result for either the buyer or the seller. Many times, acquisitions are a partnership, and you don't want to live with negative consequences that could have been avoided. So, having good advisors, including a good lawyer, is absolutely essential.

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