Understanding Deal Structure: More Than Just a Multiple on Valuation (Part 1 of 2)

In this two-part series, we break down the different elements and variables of deal structuring so med spa owners can be empowered when entering their negotiations with private equity.

What is one of the biggest mistakes we see medical spa owners make when considering a sale? Focusing solely on their EBITDA multiple.

While the multiple is a crucial factor, understanding the overall deal structure is equally important. Deal structure encompasses various components that can significantly impact your financial outcome and risk exposure. Buyers will often pay a higher multiple for your med spa if they can derisk their investment, and they do this with creative deal structuring that may result in you taking on more risk than you otherwise would. It is not uncommon for med spa owners to be unaware of these nuances, and therefore unable to negotiate effectively.

Deal structuring is a dense topic, so to keep everyone awake and increase the odds you will make it to the end, we’ve broken up the post into two parts. First we will address the various ways that the med spa seller is paid.

How the purchase price is paid, and no, it’s not all cash

One element of the deal structure outlines how the purchase price is paid and can include various forms of payment such as cash, stock, earn-outs, and seller notes. Each component can carry different implications for risk, taxation, and cash flow. There’s no avoiding business risk, but how a deal is structured will impact which class of share bears more of the risk. Not surprisingly, buyers will try to derisk their investment by building in downside protection without giving up upside opportunity. Unfortunately, if a buyer is derisking their position, it is often at your expense and any value you may receive in deferred payments.

Cash at Closing

Receiving a significant portion of the purchase price in cash at closing is often the most desirable scenario for sellers. It provides immediate liquidity and reduces the risk of future non-payment. It can also be the catalyst for a sale as operators move towards retirement and think about diversifying their personal assets. However, buyers may be reluctant to pay the entire amount upfront, especially if they perceive risks associated with your med spa’s future performance. This may result in a lower overall multiple and lower valuation than if the med spa owner had received some stock or other forms of deferred payment.

Stock and Equity

In some deals, buyers may offer you stock or equity in lieu of cash. It may be all equity or a combination of equity and cash. Continuing to hold equity can be beneficial if you believe in the future growth of your business after you sell and the opportunity for a higher valuation at the next transaction. When an acquiring business is buying smaller businesses, it is often the case that the larger, more durable platform will receive a higher multiple than the targets being acquired. Therefore, rollover equity can be worth more in the future than if sold for cash today. However, stock comes with risks, such as market volatility and potential restrictions on selling shares. It’s essential to evaluate the financial health and growth prospects of the acquiring company before accepting stock as part of the payment. Understanding what type of influence and autonomy you will maintain is also important. With less direct influence comes greater reliance on the buyer making decisions that will be in your best interest.

Earn-Outs

Earn-outs are deferred payments based on your business achieving specific performance targets post-sale. While earn-outs can bridge valuation gaps, they also carry risks. If your med spa doesn’t meet the agreed-upon targets due to market conditions or new management decisions (which are out of your control), you may receive less than anticipated. It’s crucial to clearly define performance metrics and ensure they are achievable, fair and within your control. It’s important to note that once you sell your business, you won’t be in control of all the decisions going forward so consider who you are partnering with and what will or won’t be within your control going forward.

Seller Notes

Seller notes, or promissory notes, are loans provided by the seller to the buyer as part of the purchase price. This note serves as a form of deferred payment, where the buyer agrees to pay you over time, rather than paying the full purchase price upfront. However, unlike rollover equity that has equity-like risks and equity-like returns, seller notes come in the form of debt. You will receive principal and interest payments in lieu of continuing to own a portion of the business. While seller notes can help facilitate the sale, they also introduce significant risks, especially if they are unsecured. The interest rates paid may also be artificially low for the actual risk the seller is taking.

Summary

This is a small sample of the more common tools utilized in deal structure. We’ll cover more in Part Two.

Deal structuring is a topic that is even more opaque than valuation multiples, so engaging experienced legal and financial advisors can help you understand the nuances of the deal, negotiate favorable terms, and ensure you get the best deal possible.

Consider the alignment of incentives between you and your buyer post-close. Is the acquiring company a true partner, sharing the risk and rewards of continued operations, or has the structure of the deal distorted who is bearing the risk and who is receiving the opportunity for increased returns?

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