All too often, buyers and sellers cannot reach pricing that both are comfortable with. Even a 1% pricing divide can kill a deal. Sometimes to make a deal happen, buyers decide to overpay a bit and hope some unexpected good news comes from a portfolio. Others throw in the towel. Fortunately, there are a few approaches that can help bridge small gaps in pricing. While some of these approaches call for structuring flexibility from the seller, none move the price.
Approach 1: Staging payment
Provide the seller with a portion of the purchase price up front, but then pay the remainder in the future (e.g. half up front and half in one year).
The ROI can be enhanced if the assets distribute cash before the second payment. Take a $100 deal that is expected to return $140, a 1.4x ROI. Now, delay half the price for a year and let’s say an expected $20 distribution is realized in the meantime. That $20 can be used to offset a portion of the second payment. You do not have to spend as much money to purchase the assets and this improves the ROI:
The ROI is higher albeit on a smaller deal size, and the IRR is also modestly improved. One warning: if the deal loses money, this approach amplifies the ROI downwards below 1.0x as well.
Approach 2: Leverage
An increasingly common technique for larger deals is for a buyer to get a loan and use leverage to purchase assets. There is a cost to borrow but distributions can be used to pay down the debt, which helps the ROI as in Approach 1. Leverage “loan to value” can be 20% (low end) to 60% (aggressive). It is more common on larger deals ($100 million and up) and seen on many massive deals (~$1 billion). One big risk of leverage is that if a deal goes south, leverage amplifies the damage on the downside (remember 2008?).
Approach 3: Eye of the beholder
Divide the assets with a partner that has higher pricing for some of the assets in the seller’s portfolio. They might have different insights on the underlying value of the assets. While many agents do this as part of a “mosaic” process, buyers can work together in this regard as well. Let a partner with a higher price for particular assets acquire them at their price. This will lift the combined bid, as illustrated below:
Asset A: 90 cents (on the dollar)
Asset B: 80 cents
Blended price offered to the seller: 85 cents
However introduce a partner that would happily step up and pay 85 cents for Asset B and you get:
Asset A: 90 cents
Asset B: 85 cents
Blended price offered to the seller: 87.5 cents!
Additionally, your partner should be thankful for the deal flow (and maybe will have a return favor for you down the road).
Approach 4: Delayed closing
Many sellers do not need to transact immediately, especially if a binding purchase agreement is executed. Some sellers simply need to meet a year end target for their balance sheets and annual goals. Delay the payment and closing of the transaction as long as possible. Endowments often have June 30 year ends. Some foreign sellers tend to have different year-ends such as March 31st for many Japanese institutions. It can be a low cost “give” for the seller.
This was not an exhaustive list, but hopefully here are some approaches that could be successful in a tight situation!