Lionel has spent 30 years manufacturing soccer goal nets. Now, for the first time, he is focused on a different kind of net, which is how much money he will walk away with after selling the business. His investment banker has run a competitive sale process and received indications of interest, or IOIs, from several buyers. The news is good. There is real interest in the company, and most of the buyers seem to value it at around $20 million.
What You’ll Learn
- Why a headline offer may describe enterprise value, equity value, cash consideration, or total potential consideration, and how those four terms produce very different results for the seller
- How funded debt, debt-like items, and excess cash move a $20 million enterprise value toward a smaller equity value
- What a net working capital target does to the purchase price before closing, and why cash is usually excluded from that calculation
- The nine questions worth sending back to a buyer when an IOI leaves the structure unclear
- Why a company valued at $20 million can deliver less than $10 million of usable cash on the day the deal closes
No Obvious Winner
One buyer is offering $20 million. Another is at $20.5 million. A third is a little lower at $19.5 million. All three appear capable of completing the transaction.
Lionel reads through the IOIs several times. He studies the valuation pages, looks at the proposed closing timelines, and tries to decide which buyers he likes. But he keeps coming back to the same question.
“If they are all offering about the same amount, how am I supposed to choose?”
His banker gives him a different way to look at it. Before deciding which buyers should move forward, they should model what Lionel is likely to net from each offer.
A $20 Million Offer Does Not Mean $20 Million to the Seller
Business owners tend to focus on the largest number in an offer. That makes sense. Price matters.
But the number at the top of an IOI is usually only the starting point. It may describe enterprise value, equity value, cash consideration, or total potential consideration. Those terms can produce very different results.
Consider three simplified offers for Lionel’s business.
| Item | Buyer A | Buyer B | Buyer C |
| Headline value | $20.0M | $20.5M | $19.5M |
| Cash consideration | $20.0M | $15.5M | $17.5M |
| Earnout | – | $3.0M | – |
| Seller note | – | $1.0M | – |
| Rollover equity | – | $1.0M | $2.0M |
Buyer B has submitted the highest headline offer. But only $15.5 million is identified as cash consideration. Another $3 million depends on the company reaching future performance targets. Lionel would finance $1 million of the acquisition through a seller note and reinvest another $1 million into the buyer’s company.
Buyer A is offering less total value, but all of the stated consideration is cash.
Buyer C has the lowest headline value, but its offer may allow Lionel to retain an equity interest in a larger company that could appreciate over time.
And none of these numbers yet accounts for debt, working capital, transaction expenses, taxes, or the amount of cash that may be held back after closing.
The offers are close on price. They are not close in economic terms.
Start With Enterprise Value
Many M&A offers are expressed as an enterprise value. This is the value assigned to the operating business before certain balance-sheet and transaction adjustments.
Suppose Buyer A offers Lionel $20 million of enterprise value.
If Lionel’s company has $1.5 million of bank debt, that debt will normally need to be paid off at closing. Lionel does not receive the $20 million and hand the buyer a company with the debt still attached. The debt is paid from the transaction proceeds.
That gets Lionel from a $20 million enterprise value to $18.5 million before considering anything else.
The calculation could also include equipment financing, a balance on the company’s revolving line of credit, unpaid transaction expenses, accrued employee bonuses, certain lease obligations, and other items the buyer considers debt-like.
Some of those items will be straightforward. Others will be negotiated. Either way, they affect the bridge between the value assigned to the business and the proceeds available to its owner.
Then Comes Working Capital
Lionel’s company buys raw materials, carries finished soccer goal nets in inventory, and gives certain customers time to pay their invoices. It also owes money to suppliers and has payroll and other operating expenses that accrue between payment dates.
The buyer expects to receive a functioning company with a normal level of these operating assets and liabilities.
That expectation is usually reflected in a net working capital target, sometimes called a working capital peg. If Lionel delivers less working capital than the agreed target, the purchase price may be reduced. If he delivers more, he may receive an upward adjustment.
At this point, Lionel misunderstands the concept. He thinks net working capital means he must leave cash in the company. It generally does not. Cash is normally excluded from the working capital calculation and treated separately.
That issue deserves its own discussion, and we will address it later in this series. For purposes of comparing the IOIs, Lionel and his advisors still need a preliminary estimate of the likely working capital target and whether the company is expected to deliver more or less than that amount at closing.
A difference of several hundred thousand dollars can change which offer produces the best result.
The Cash Flows In, Just Not All at Once
Lionel also needs to separate total consideration from cash he can use immediately.
A buyer may propose to hold back part of the purchase price in escrow. Those funds may remain unavailable for a year or more and could be used to satisfy certain post-closing claims.
An earnout may be included in the headline price even though payment depends on future revenue, gross profit, earnings before interest, taxes, depreciation, and amortization, or another performance measure. Lionel may believe strongly in the company, but after closing he may no longer control its hiring, pricing, spending, or accounting decisions.
A seller note introduces a different risk. Lionel has technically sold the company, but he is still waiting for the buyer to pay part of the purchase price. If the business struggles or the buyer becomes overleveraged, collection may become difficult.
Rollover equity can create meaningful upside. It is also illiquid and dependent on the future performance of the buyer’s larger platform.
These forms of consideration may all have value. But a dollar in an earnout, seller note, or private-company equity is not interchangeable with a dollar wired to Lionel at closing.
Fees and Taxes Come Out of What Remains
Lionel will also incur expenses to complete the transaction. Depending on the deal, these may include investment banking fees, legal bills, accounting and tax work, employee transaction bonuses, and other professional expenses. Some may be paid by the company before closing. Others may be paid directly from the transaction proceeds.
Then there are taxes.
The tax result may depend on whether Lionel is selling equity or assets, the company’s legal structure, his tax basis, the treatment of inventory and equipment, the purchase price allocation, his state of residence, and the form and timing of the consideration.
A $20 million asset sale can produce a different after-tax result from a $20 million equity sale. A $3 million earnout can be taxed differently from a $3 million rollover. Employment and consulting payments may receive different treatment from purchase price.
This does not mean Lionel can calculate his taxes perfectly from a three-page IOI. He cannot. But he can identify the major structural differences and estimate the likely range of outcomes.
Building Lionel’s Gross-to-Net Model
Lionel’s banker builds a model for each offer using the following calculation:
| Gross-to-Net Item | Illustrative Amount |
| Headline enterprise value | $20.0M |
| Less: funded debt | ($1.5M) |
| Less: debt-like items | ($0.5M) |
| Plus: excess cash | $0.5M |
| Less: estimated working capital adjustment | ($0.3M) |
| Estimated equity value | $18.2M |
| Less: transaction and employee expenses | ($1.2M) |
| Estimated pre-tax proceeds | $17.0M |
| Less: estimated taxes | ($4.2M) |
| Estimated after-tax proceeds | $12.8M |
The model then divides those proceeds by form and timing:
| Form of Proceeds | Illustrative Amount |
| Cash available at closing | $9.8M |
| Cash held in escrow | $1.0M |
| Seller note | $1.0M |
| Rollover equity | $1.0M |
| Total estimated after-tax value | $12.8M |
These figures are hypothetical, and an actual analysis would depend on the company, transaction structure, and applicable tax rules. But the example shows why Lionel cannot select a buyer based on headline value alone. The company may be valued at $20 million while Lionel receives less than $10 million of immediately available cash after closing.
The Model Does Not Need to Be Perfect to Be Useful
At the IOI stage, there will be unanswered questions.
The buyers may not have proposed a working capital target. Their definition of debt-like items may be unclear. The rollover equity terms may be only a paragraph long. The tax structure may remain open for discussion.
The banker’s job is not to pretend that the answers are known. It is to identify the assumptions, show Lionel where the offers differ, and determine which questions need to be answered before he chooses a buyer.
That may mean going back to the parties and asking:
- Is the stated valuation enterprise value or equity value?
- How much consideration will be paid in cash at closing?
- What working capital assumption supports the offer?
- Which liabilities will be treated as debt-like?
- How will the earnout be calculated?
- What are the repayment and security terms of the seller note?
- What equity is Lionel receiving in the rollover?
- How much will be placed in escrow?
- Is the buyer proposing an asset purchase or an equity purchase?
The answers may change the ranking. In our experience, a buyer that looked strongest on the first page can move to the bottom once the structure is priced out. A slightly lower offer may provide more cash, less risk, and a better after-tax result. Another offer may remain attractive because Lionel values the potential upside from rollover equity, even though it produces less liquidity at closing.
There is no universal answer. The right choice depends partly on Lionel’s goals. But he cannot make that choice intelligently until the offers are translated into the same terms.
Comparing Offer Details
Lionel’s banker does not tell him to ignore the headline purchase price. A higher price is generally preferable when the other terms are equal.
The problem is that the other terms are rarely equal.
Purchase price, payment structure, working capital, debt, expenses, and taxes all affect what the sale means to the seller. The differences can be substantial even when the IOIs appear to be clustered around the same valuation.
In the rest of this series, we will follow Lionel through each part of that analysis, including how the purchase price is paid, what net working capital means, which fees and liabilities reduce proceeds, and how deal structure affects taxes.
Lionel entered the process trying to determine which buyer was offering the most for his company. The gross-to-net analysis helped him ask a better question. Which transaction leaves him with the best outcome when the deal is done?
The next article in the series looks at how cash, earnouts, seller notes, escrows, and rollover equity each change what a seller receives. If you are weighing offers on your own business and want a second read on what they mean in net terms, we welcome the opportunity to discuss it. Contact the team at Roadmap Advisors to start that conversation.
Editorial note: The examples and figures in this article are hypothetical and simplified for educational purposes. Transaction terms and tax consequences vary based on the facts. Business owners should consult qualified M&A, legal, accounting, tax, and wealth-planning advisors regarding their specific circumstances.
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