Innovative Purchase Price Mechanisms: Responses to Economic Uncertainties in the M&A Sector

published on 25 November 2024 | reading time approx. 4 minutes

The structuring of the purchase price is a critical aspect of M&A transactions, as it balances the interests of buyers and sellers in a complex and dynamic market environment. Especially in times of economic uncertainty, such as in 2023 and 2024, the flexibility in purchase price structuring gains importance. Uncertainties in the global market, rising interest rates, geopolitical tensions, and changes in regulatory frameworks led to M&A deals being increasingly structured with specific mechanisms to minimize risks and bridge financing gaps.

In the German M&A market, 2023 was a year of adapting to these new realities. The rising interest rates, introduced by the European Central Bank (ECB) to combat inflation, significantly increased the costs of debt financing. As a result, both buyers and sellers had to find more creative solutions to successfully complete transactions. At the same time, uncertainty about economic recovery made it difficult to perform reliable company valuations. This led to more flexible purchase price structures to better distribute risks between the parties. Many companies, particularly in the technology, healthcare, and renewable energy sectors, relied on adjusted price structures to integrate future growth and performance into the pricing.

In 2024, some of these uncertainties stabilized, especially with a cooling of inflation rates and a milder interest rate trend. However, many of the mechanisms established in the previous year, such as earn-outs and vendor loans, remained a central element in the structuring of purchase prices. The stabilization of the markets created room for new strategic acquisitions, and at the same time, ESG factors (Environmental, Social, and Governance) and the ongoing technological transformation contributed to companies continuing to use alternative structures to better manage risk. Many acquisitions aimed not only to create immediate value but also to achieve long-term strategic goals, which favoured flexible purchase price mechanisms like earn-outs, vendor loans, and equity rollovers.

The following purchase price mechanisms have proven particularly effective and are expected to continue to play a central role in M&A structuring in the future:

Earn-Outs: In company acquisitions where valuation is fraught with significant uncertainties, variable purchase price agreements, also known as "earn-outs," are often used. A portion of the purchase price is paid depending on the future economic development of the company, divided into a fixed and a variable component. Typical reference points for this calculation are EBIT or EBITDA, with periods typically ranging from one to three years. To minimize conflicts, agreements with a variable scale are often used, which provide for a gradual payout based on economic targets achieved. It is important that these formulas are kept clear and simple to avoid interpretation conflicts between the parties involved. For the seller, it is also essential to verify the financial stability of the buyer both at the time of entering the company and in terms of the outstanding earn-out payments.
Vendor Loans: In a vendor loan, the purchase price is often deferred and interest-bearing, with the seller by this "Vendor Loan" carrying a share of the external financing. This method is particularly suitable for bridging information asymmetries and building trust in the valuation of the operational risk of a company. Furthermore, by offering a vendor loan, the seller demonstrates his confidence in the future positive development of the company, even if he can no longer exert the same influence as before. If the seller remains as CEO in the company for some time, he can still significantly influence the operational development and thereby reduce his own risk from the loan. The legal structure of the vendor loan is usually carried out by a loan agreement, which is included as an annex to the share purchase and transfer agreement. Typically, the vendor loan is subordinated to bank loans and unsecured, although it is occasionally possible to offset the loan against warranty claims of the buyer. Given the currently high level of interest rates, the above-average high interest rates of the vendor loan are particularly attractive and thus also an attractive investment opportunity for the seller.
Equity Rollover (Reinvestment): In a transaction where the seller participates in the acquisition vehicle of the buyer through a reinvestment, he invests parts of his sales proceeds as equity and thus becomes a co-shareholder of the acquiring company. This allows him to continue to benefit from future value increases of the company. Such reinvestments are typical for private equity transactions to foster long-term partnerships and align the interests of seller and buyer. The seller remains engaged with all the rights and duties of a shareholder and can also benefit from the leverage effect of debt financing. The provision of additional equity through the reinvestment extends the financing framework of the acquirer, which may result in the acquirer having to raise less equity itself. However, a reinvestment could be problematic if the seller intends to leave the company after the transaction, as it generally implies a continued commitment of the seller to the company.
Withheld Purchase Payments: The mechanisms Escrow and Holdback serve to withhold part of the purchase price under certain conditions to protect the buyer from subsequent risks. In the Escrow, the money is deposited in a trust account of an independent third party and is only released upon fulfilment of specified conditions. The Holdback mechanism also withholds a part of the purchase price, but this is directly managed by the buyer and not through a trustee. Both methods are particularly relevant in risk-prone or capital-intensive industries to provide security and minimize risks.

By combining these mechanisms, M&A deals were successfully completed in 2023 and 2024 despite a challenging market environment. For the future, it is expected that these structures will continue to gain importance as companies look for flexible and secure ways to finance transactions and manage risks.