Summary
Learn how to structure private acquisition deals when a business is fundamentally good but carries real risks, and how tools like earnouts, escrows, and seller notes help allocate uncertainty between buyer and seller more fairly.
Most deals worth doing have at least one thing that gives you pause.
A customer who represents too much revenue. An owner whose departure creates a dependency you can’t fully address before close. A financial metric that is slightly better than you’d expect for a business of this type, in a way that deserves an explanation you haven’t fully verified. A market dynamic that could go either way over the next three years.
The instinct in the face of that kind of risk is binary: either accept it and proceed, or walk away. Most search funders who have been in the process for a while know that neither of those responses is usually the right one. The right one is to understand the risk precisely enough to price it, structure around it, and allocate it between buyer and seller in a way that makes the deal fair to both parties given the actual uncertainty involved.
Deal structure is where that precision gets translated into commercial reality. It’s one of the most underappreciated skills in private acquisition and one where the quality of your due diligence determines almost everything about your ability to do it well.
In this article
- The Principle Behind Every Structural Decision
- The Main Structural Mechanisms and When to Use Each One
- Risk Mapping: Translating Due Diligence Into Structure
- The Due Diligence Foundation That Makes Structure Possible
The Principle Behind Every Structural Decision
Every deal structure mechanism (earnouts, escrows, seller notes, deferred consideration, completion accounts) exists to solve the same underlying problem: there is something uncertain about this business that the buyer and seller value differently, and a cash-at-close structure forces one of them to bear all of the uncertainty while the other bears none.
Structural mechanisms distribute that uncertainty more fairly. They allow a deal to close at a price both parties can accept by making a portion of the consideration contingent on what actually happens, which is almost always a better representation of the true risk than either the seller’s optimistic view or the buyer’s conservative one.
That principle has a practical implication: the right structure for a given risk depends on who controls it. A customer retention risk that is primarily driven by the owner’s personal relationships is best addressed by an earnout that makes the seller financially accountable for retention, because they’re the one with influence over whether it materialises. A financial risk driven by an add-back that couldn’t be fully verified is best addressed by an escrow, because neither party controls it, and the cash needs to be available if it turns out to be wrong. Getting that mapping right requires understanding the risk precisely, which requires thorough due diligence.
The Main Structural Mechanisms and When to Use Each One
| Mechanism | Purpose | Best Used For | Key Advantages | Watch Outs |
|---|---|---|---|---|
| Earnout | Makes part of the purchase price contingent on achieving post-close performance targets (typically revenue or EBITDA). Bridges valuation gaps by linking consideration to actual future performance. | • Customer retention risk • Revenue durability uncertainty • Valuation gaps driven by optimistic growth projections | • Aligns seller incentives with buyer outcomes • Reduces upfront risk for buyer • Allows seller to capture upside if performance is achieved | • Earnout periods longer than 2 years reduce motivation • Metrics may be manipulated • Overly complex structures can create disputes • Revenue metrics may incentivize growth at the expense of profitability |
| Escrow | Holds a portion of the purchase price in a third-party account to cover potential claims or liabilities that emerge after closing. | • Unverified add-backs • Warranty and indemnity exposure • Financial statement accuracy risk • Undisclosed liabilities | • Protects buyer against known but unquantifiable risks • Ensures funds are available if issues arise • Does not depend on seller involvement after closing | • Escrow periods may be too short for claims to surface • Release conditions may be too favorable to seller • Escrow amounts should match the actual risk, not arbitrary percentages |
| Seller Note | Defers a portion of the purchase price, typically with interest, to be paid over time after closing. | • Financing gaps • Alignment on future earnings expectations • Situations where seller goodwill remains valuable post-close | • Helps complete deals where financing is insufficient • Signals seller confidence in future cash flows • Maintains seller’s economic interest in business success | • Subordination to senior debt can create tensions if performance weakens • Interest rates may not adequately compensate seller for risk • Deferred payments increase ongoing financial obligations |
| Completion Accounts | Adjusts the purchase price after closing based on the actual working capital and net debt position at completion. | • Deals with meaningful receivables, payables, or inventory • Situations where working capital may fluctuate before closing • Concerns about balance sheet normalization | • Protects against pre-close balance sheet manipulation • Ensures buyer receives an appropriate level of working capital • Aligns purchase price with actual financial position | • Working capital targets must be supported by historical analysis • Poorly defined targets lead to negotiation disputes • Requires detailed financial diligence and monitoring |
The right structure for a given deal is not a standard template applied to every transaction. It’s a specific response to the specific risk profile of this business, identified during due diligence and translated into commercial mechanisms that allocate each risk to the party best positioned to bear it.
| Risk identified in due diligence | Who controls it | Right structural response |
|---|---|---|
| Customer revenue is owner-relationship-dependent | Seller: their relationships, their introductions | Earnout tied to named customer revenue retention in years one and two |
| Add-back couldn’t be fully verified | Neither party: historical uncertainty | Escrow sized to the add-back amount, released after verification period |
| Working capital compressed in pre-sale period | Seller: they managed the balance sheet | Completion accounts with normalised working capital target based on 24-month average |
| Key employee whose retention is uncertain | Partly seller, partly employee | Seller retains advisory role with compensation tied to employee retention; direct retention arrangement with employee |
| Valuation gap, seller believes growth projection, buyer doesn’t | Neither: forward uncertainty | Earnout tied to EBITDA in years one and two; base price reflects buyer’s conservative case |
| Legal matter that may result in a claim | Neither: external uncertainty | Specific indemnity with no cap for the named matter; general warranty and indemnity insurance for broader coverage |
| Financing gap between debt and equity | Both: shared interest in close | Seller note for the gap, subordinated to senior debt, with market-rate interest |
The Due Diligence Foundation That Makes Structure Possible
Deal structure is only as good as the due diligence behind it. You can only structure around a risk you’ve identified clearly which means vague, impressionistic due diligence produces vague, inadequate structural protection.
The search funder who walks into a deal negotiation knowing that three specific customers representing 45% of revenue have contracts that name the owner personally, that the working capital position compressed by £180,000 in the twelve months before sale, and that one add-back of £42,000 appears in two prior years under a different description, that search funder has the specific, quantified information needed to negotiate structural protections that actually address the risks rather than gesturing at them.
The search funder who knows only that “there’s some customer concentration and the working capital looks a bit high” is negotiating from a position that produces either too little structural protection or too much friction, because they can’t justify the specific mechanisms they’re asking for with specific evidence.
References
- https://hbr.org/2014/03/structuring-deals-to-manage-risk-in-m-a
- https://hbr.org/2020/02/the-art-of-the-deal-in-mergers-and-acquisitions
- https://www.mckinsey.com/capabilities/strategy-and-corporate-finance/our-insights/mergers-and-acquisitions
- https://www.bain.com/insights/mergers-and-acquisitions/
- https://www.pwc.com/gx/en/services/deals/mergers-acquisitions.html
- https://www2.deloitte.com/global/en/pages/mergers-and-acquisitions/articles.html
- https://www.investopedia.com/terms/e/earnout.asp
