Deal Structuring: Financial Considerations for Transaction Services Teams
Deal structure is not just a legal question. It has direct financial consequences for both buyer and seller. The choice between an asset deal and a share deal, the treatment of pre-close liabilities, the allocation of tax attributes, and the price adjustment mechanism all depend on findings from financial due diligence.
Transaction Services teams that understand structuring implications deliver more valuable advice. Their diligence findings inform structure decisions that can move deal economics by millions of dollars.
Asset Deal vs Share Deal
The fundamental structural choice in most transactions is whether the buyer acquires the target's assets or its shares (equity interests).
Asset deal advantages for the buyer:
- Cherry-pick desired assets and leave behind unwanted liabilities
- Obtain a tax basis step-up in acquired assets, creating future depreciation and amortization deductions
- Avoid inheriting unknown or contingent liabilities that remain with the selling entity
Share deal advantages for the buyer:
- Contractual relationships, permits, and licenses typically transfer automatically
- Simpler execution for targets with complex asset structures
- Preservation of tax attributes (NOLs, credits) that may be lost in an asset deal
The diligence team's findings directly inform this choice. If the balance sheet quality review reveals significant contingent liabilities, environmental exposures, or undisclosed obligations, an asset deal provides better protection. If the target has valuable tax attributes or complex contractual relationships, a share deal may be preferred.
Liability Allocation
Every deal structure must address how pre-close liabilities are allocated between buyer and seller. The diligence team's identification of debt-like items and contingent liabilities provides the inventory of items that need structural treatment:
Retained by seller. Liabilities that the seller retains and does not transfer. Common in asset deals for pre-close litigation, tax disputes, and environmental obligations.
Assumed by buyer. Liabilities that transfer to the buyer as part of the acquisition. In share deals, substantially all liabilities transfer unless specifically carved out.
Indemnified by seller. Liabilities that transfer to the buyer but for which the seller provides contractual indemnification. The SPA defines the scope, caps, baskets, and duration of indemnities.
Insured. Liabilities addressed through representations and warranties insurance (RWI) or specific liability insurance policies. Insurance solutions have become standard in private equity transactions.
The diligence team should map each identified liability to the appropriate structural treatment and quantify the financial exposure under each allocation scenario.
Earn-Out Structures
Earn-outs bridge the valuation gap between buyer and seller by making a portion of the purchase price contingent on post-close performance. Financial due diligence informs earn-out design in several ways:
Metric selection. Revenue, EBITDA, or gross profit are the most common earn-out metrics. The diligence team's quality of earnings work determines which metric is most appropriate and how it should be defined.
Target setting. Historical performance analysis provides the baseline for earn-out targets. Targets should be set at levels that are achievable but stretch, based on the diligence team's assessment of sustainable earnings.
Accounting policy definition. The earn-out agreement must specify the accounting policies used to calculate the earn-out metric. Ambiguity in these definitions is the most common source of earn-out disputes.
Manipulation risk. The buyer controls the business post-close and may have incentives to depress the earn-out metric. The diligence team should identify areas where post-close accounting choices could affect the earn-out calculation and recommend protective provisions.
Carve-Out Considerations
When the target is a division or business unit of a larger entity, the deal is structured as a carve-out. This creates unique financial diligence challenges:
Standalone financials. The diligence team must assess or construct standalone financial statements that reflect the business on an independent basis. Corporate allocations must be replaced with actual or estimated standalone costs.
Transitional service agreements. The carved-out business may depend on the parent for shared services (IT, finance, HR, procurement). TSA terms affect the post-close cost structure and should be analyzed during diligence.
Stranded costs. Costs that remain with the parent after the carve-out but were historically allocated to the target. These reduce the parent's profitability but do not burden the acquired business.
For detailed carve-out analysis, see our discussion of carve-out due diligence.
Tax Structuring
Deal structure has significant tax implications:
Step-up benefits. In asset deals, the buyer receives a tax basis step-up in acquired assets. The present value of future tax deductions from this step-up can be worth 10 to 20 percent of the purchase price. The diligence team should estimate the step-up benefit to inform the structure decision.
Tax attribute preservation. In share deals, the target's tax attributes (NOLs, credits) may be available to the buyer, subject to change-of-control limitations. The tax diligence team should quantify the available attributes and assess limitations.
Withholding and transfer taxes. Cross-border deals may trigger withholding taxes on purchase price payments, stamp duties, or transfer taxes. These transaction costs affect net proceeds and should be modeled in the deal economics.
Price Mechanism
The deal structure includes the price adjustment mechanism. The diligence team's analysis supports both common approaches:
Completion accounts. Post-close adjustment based on the actual balance sheet at closing. Requires detailed diligence on working capital normalization, net debt definition, and accounting policies.
Locked box. Fixed price based on a historical balance sheet date. Requires thorough verification of the reference balance sheet and monitoring of no-leakage covenants.
The choice between these mechanisms is part of the broader deal structure negotiation. The diligence team should present the financial implications of each approach to inform the buyer's decision.