1. Why Deal Structuring?

The value of a company is determined by the future cash flow streams the company is expected to generate for its providers of capital as well as the riskiness of these future cash flow streams. Because the future cash flow streams as well as their riskiness are unknown today, there is usually no such thing as the one and only true value of a company:

  • Different management teams might be able to generate different cash flow streams (and risks)
  • Different parties might read the same information in different ways (for example, some might see digitalization as an opportunity whereas others see it as a threat)
  • There is usually information asymmetry (the management generally knows more about the strengths and weaknesses of the product than potential external investors)
  • Different stakeholders might be subject to different regulations (e.g., taxes)
  • Different stakeholders might have different incentives (e.g., a financial investor might want to push the company for an Initial Public Offering whereas the founder would prefer to pass it on to her kids)
  • There could be potential conflicts of interest (e.g., a shareholder could also be a large investor in a competitor).
  • etc.

All these aspects imply that different parties will most likely disagree about the (potential) future cash flow streams of the firm as well as their riskiness. If they disagree about the cash flow streams and their riskiness, they will most likely also disagree about the "fair" value of the firm

Deal structuring helps us find deals even if the buyers and sellers cannot agree on a price. The trick will be to identify the source or the nature of the disagreement and incorporate it in the deal.

For example, a buyer and a seller could disagree about the firm's future revenue growth. If the seller is more optimistic than the buyer, he will most likely ask for a higher price than what the buyer is willing to pay. To address this disagreement, we could tie the ultimate transaction price to the firm's future revenues: If the seller is right and the firm's revenues develop favorably, he should get an extra compensation. This is a simple earnout agreement, a feature that many corporate transactions have in common.

More generally speaking, deal structuring is about the allocation of cash flow streams (amount and timing) as well as the allocation of risk. Thereby, deal structuring determines the allocation of value between the parties of the deal.

As we will see in great detail in this module, finding an appropriate deal structure is absolutely crucial. Some of the reasons include:

  • Without deal structuring, deals are often not possible
  • The structure of the deal can have far reaching implications for the incentives of the parties of the deal (in the above example of an earnout agreement, tying the transaction value to the firm's future revenues gives the seller a high-powered incentive to work hard so that revenues actually grow)
  • The structure of the deal can affect the nature of the cash flow stream (amount, timing, risk).
  • We can use deal structuring as a "truth serum." In the above example, a pessimistic seller would probably not agree to the earnout. If he agrees to the earnout, the buyer learns that the seller is indeed optimistic about the prospects of the firm.
  • With the right deal structure, we will generally be able to improve the value of the transaction to the parties involved.