When is Deferred Consideration Treated as "Borrowings"?

Deferred consideration refers to a portion of the consideration for the acquisition of an asset or shares that is (or may become) payable in the future rather than at the completion date of the acquisition. Deferred consideration can be contingent or non-contingent.

Non-contingent

Non-contingent deferred consideration is a fixed or determinable amount that will become due and payable at a future date without any conditionality. Given that its financial impact is known upfront, lenders under mid-market private credit loan documentation should ensure that non-contingent deferred consideration constitutes "Financial Indebtedness" and "Borrowings" (and is therefore included in the borrower group's debt calculations for the purposes of financial covenant and incurrence testing). It forms part of the leverage of the borrower group as a fixed payment obligation – akin to a loan repayment obligation.

Contingent

Contingent deferred consideration (such as earn-outs) is different – it may or may not become payable with its payment being dependent on a range of factors, for example, whether the acquired target achieves certain performance milestones or targets. The amount of contingent deferred consideration also may depend on which milestones/targets are (or are not) achieved. Since it is contingent and unquantifiable at the outset, mid-market private credit loan documentation typically provides (and Lenders should be fine to accept) that contingent deferred consideration only constitutes "Financial Indebtedness" and "Borrowings" to the extent and from the time that it becomes certain, with the nuance that it is then captured in “Financial Indebtedness” and “Borrowings” (in the same way as a loan) even if it is not yet due and payable.

Further Points to Consider

In addition, private credit lenders typically seek to include some or all of the following controls on deferred consideration in their loan documentation:

• a cap on the amount of deferred consideration for any permitted bolt-on acquisition and any permitted disposal (usually expressed as a percentage of the total purchase price);
• requirement for vendors to subordinate their claims with respect to deferred consideration to the senior facilities; and
• inclusion of pro forma financial covenant compliance and no event of default as conditions to permitted payments out of the borrower group in order to pay deferred consideration.