Being Paid in Paper Means Lending Part of Your Price Back

Cash is the only form of consideration with no valuation argument attached and no exposure after closing. Everything else is a claim on something that still has to happen.

That is not an argument for refusing paper. Deals get done with it constantly, and sometimes the paper is what makes a better headline available. It is an argument for pricing it as what it is.

What each form actually makes you

A seller note means you have lent the buyer part of your own purchase price. You are now a creditor of the company you used to own.

Buyer stock makes you an investor in the buyer. You are exposed to how they run their business, and if the stock is not publicly traded you are exposed to it without a price and without an exit.

Rolled equity keeps a stake in the business going forward. You are now a minority owner with a partner, a governance structure, and a second transaction in your future.

An earnout makes you a partner in a business you do not control.

Four different instruments, one common feature: in each one, part of your price depends on events after the day you hand over the company.

What to read in a seller note

The security. Is the note secured against anything, and against what. A security agreement accompanying the note records your interest in the collateral named in it, and that document is what decides whether a deferred payment is secured or merely written down.

The subordination. Where you sit relative to the buyer’s lender. In most acquisition financings the answer is behind them, and the terms of that subordination decide what you are permitted to do if payments stop.

What happens when the lender gets nervous. Subordination agreements commonly let a senior lender block payments to you during a default or a covenant breach, for a stated period. That provision is the one that determines whether your note is an asset or a hope in the one scenario where it matters.

Who is obligated. The operating company, or a holding entity with nothing in it. And whether there is a personal guarantee behind it or only a signature.

Underwrite them the way a lender would

If every dollar arrives at closing, you are asking whether the buyer can pay on one day. If part of your price is deferred, you are asking whether they can pay across years, and that is a different question with a different method.

What does the combined company’s cash flow look like after the acquisition debt. What else sits in front of you in priority. What happens to your payments in a bad year. What is the buyer’s record of actually paying sellers.

Owners accept deferred consideration as a term of price. It is also an extension of credit, and nobody extends credit to a borrower they have not underwritten.

Buyer stock has a specific trap

Stock in a public company has a price, and the question is mostly about restrictions: how long you are locked up, what you can sell and when.

Stock in a private buyer has no price. What it is worth is whatever somebody eventually pays for it, on a date somebody else chooses, and in the meantime you hold a minority interest in a company whose capital allocation, further fundraising, and eventual exit are decided by people who are not you.

The terms that govern that are negotiable at the moment the deal is struck and essentially unnegotiable afterward: whether you are carried along at the same price when they sell, whether you can be bought out earlier, whether you can be diluted, and what information you are entitled to in the meantime.

The closing-day math nobody runs

Here is the piece to work out before you agree to a structure heavy in paper.

Your advisor’s fee is calculated on all consideration, including the paper, and paid in cash at closing. Add to that the tax due on a gain you have realized without having received all of it.

Closing-day cash runs well below the headline in most deals, and furthest below it in the ones that look most generous. A structure with a large deferred component and a strong headline can produce less closing-day cash than a lower all-cash number, and the only way to know is to model both.

When paper is the right answer

When the deferred piece is buying you something specific.

A buyer who wants an asset structure is asking you for a tax treatment that is worth real money to them, and that is tradeable. A buyer who cannot stretch to your number in cash but can in cash plus a note has told you what the gap costs. A rolled stake in a business you believe in, on terms that protect the minority, is a genuine second bite.

What makes those good trades is that the thing you are taking back was priced. What makes paper a bad trade is accepting it because it arrived in the offer and the headline looked right.

What getting it wrong costs

The amount, and then the collection.

An owner who takes a quarter of their price in an unsecured note subordinated to a lender, from a buyer nobody underwrote, has not sold a company for the headline figure. They have sold most of a company and made a loan on terms no bank would have accepted, to a borrower they did not examine, at the exact moment they stopped having any ability to influence whether it gets repaid.

And the fee and the tax on that quarter were both paid in cash, on closing day, years before the money arrives.

More on this: An Earnout Is Not a Price. It Is an Argument You Agreed to Have Later.; How to Tell Whether a Buyer Can Actually Pay You.

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This is what we do. Prism Edge prices the paper against the headline: what the security and the subordination actually permit, what the buyer’s cash flow supports after the acquisition debt, and what your closing-day cash is once the fee and the tax on the full gain are both in the model. Then the deferred piece is something you traded for rather than something you accepted.

The full chapter on structuring the transaction is in The Business Sale, free to download here.

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General information, not legal, tax, or financial advice, and no advisor relationship is created by reading it. Rules change and the specifics of your situation matter. Always consult your own attorney and accountant before acting.