Defining Deferred Consideration Agreement
A Deferred Consideration Agreement is a legally binding contract wherein the payment of the agreed-upon consideration is postponed to a future date or contingent upon the occurrence of a designated and certain event. This type of agreement is commonly utilized in cases of mergers and acquisitions (M&A), real estate transactions, and other scenarios where immediate payment is not feasible or desirable.
Key Features:
- Conditional Payment: Payment is either scheduled for a specific date or dependent on the completion of a future event.
- Legal Binding: The agreement is legally enforceable, ensuring both parties adhere to the specified terms.
- Flexibility: Offers flexibility for buyers to manage cash flow and sellers to obtain the full value potentially dependent on future performance or other criteria.
Examples
- Mergers and Acquisitions: A company acquires another company but agrees to pay part of the purchase price after meeting defined sales targets over the next two years.
- Real Estate Transactions: A purchaser agrees to pay the full property price once construction milestones are met.
- Business Purchases: Buying a business where the buyer agrees to an initial payment with the balance due in installments contingent upon future profits.
Frequently Asked Questions
What is the purpose of a Deferred Consideration Agreement?
The purpose is to provide flexibility in financial transactions, allowing the deferral of payments to better manage cash flows or depend on future performance, thus aligning interest between buyers and sellers.
What are the risks associated with deferred consideration?
Risks include the potential non-occurrence of the contingent event, the buyers’ liquidity at the time of payment, and the need for accurate and timely triggers for release of payment.
How is deferred consideration accounted for?
Deferred consideration is noted as a liability on the buyer’s balance sheet until the consideration is paid or due.
Can deferred consideration include interest?
Yes, deferred consideration can include interest, especially if there is a considerable time delay before payment.
Are Deferred Consideration Agreements used internationally?
Yes, they are common in international transactions, especially in cross-border M&A activities where regulatory approvals and other contingencies might delay payments.
Related Terms
Earnout
A contractual arrangement where the seller of a business may receive additional future compensation based on the business achieving certain financial goals.
Contingent Liability
A potential obligation that may arise depending on the outcome of a future event - often relevant in litigation or uncertain financial obligations.
Installment Sale
A sale where payments are received by the seller over multiple periods, which can help manage tax liabilities and cash flows.
Payment Terms
The specific conditions under which payment will be made, such as due dates, interest, and penalties for late payments.
Online Resources
Suggested Books for Further Studies
- “Mergers and Acquisitions from A to Z” by Andrew J. Sherman - A comprehensive guide on the entire M&A process, including deferred considerations.
- “Business Accounting” by Frank Wood and Sheila Robinson - A fundamental book covering various accounting practices including deferred considerations.
- “Valuation for Mergers and Acquisitions” by Barbara S. Petitt, Kenneth R. Ferris - Focuses on valuation practices, including issues related to deferred payments.
Accounting Basics: “Deferred Consideration Agreement” Fundamentals Quiz
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