9d ago in Private Equity
Vendor Financing For Private Equity Deals
endor financing, a common structure in private equity, allows a buyer and seller to bridge gaps in valuation expectations by deferring part of the purchase price. In this arrangement, the seller agrees to receive part of the sale price over time instead of in full at closing. This can be an appealing option for sellers looking to complete a deal and for buyers who wish to spread financial commitments and manage cash flow effectively.
For instance, in a scenario where a business is valued at $100 million, the buyer might pay $60 million upfront and defer $40 million, which may come with interest, depending on the terms negotiated. The timeline and structure for the deferred payment can vary, ranging from a lump sum after several years to installments over an extended period or even tied to the eventual sale of the business by the new owner.
In private equity, vendor financing is used strategically to meet the needs of both parties. If a seller wants a specific price—say, $85 million—but the buyer can only justify a $70 million valuation, deferring part of the payment allows the buyer to align the deal with their financial targets. This deferred payment has a lower present value due to the time value of money. For example, if the deferred $35 million is due in three years with an assumed discount rate of 20%, its present value calculates to $20.25 million. The buyer, who pays $50 million upfront, effectively values the deal at $70.25 million when considering the discounted future payment.
Vendor financing differs from earnouts, where future payments hinge on achieving certain financial milestones. With vendor financing, the payment is typically fixed, though it may carry an agreed-upon interest rate to balance the risk for the seller and ensure a favorable arrangement for the buyer.
An illustrative case could involve a private equity firm evaluating a purchase based on EBITDA and a multiple. If the seller seeks more than the buyer’s maximum justified price, vendor financing can bridge the gap. For example, if the firm is interested in buying a company with an EBITDA of $10 million and determines a valuation limit of 7x EBITDA ($70 million), but the seller demands $85 million, the buyer could offer $50 million upfront and defer $35 million for payment in three years. With a 20% discount rate, the deferred $35 million is presently valued at $20.25 million, making the overall perceived value approximately $70.25 million.
If the transaction proceeds and the business grows as planned, the buyer may use increased cash flow or additional debt to pay the deferred sum and still achieve substantial returns upon exit. The potential risk lies in scenarios where the business underperforms, which could require tapping into additional equity to meet deferred payment obligations. Nonetheless, this risk aligns with the original valuation the buyer deemed acceptable.
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Vendor Financing For Private Equity Deals
