Assume that Buyers and the board of directors of a Target company cannot agree on price for a possible LBO. If the Target is a public company (with a diverse set of shareholders), it would be difficult to bridge the gap on value with a seller note and/or earn-out. If the Target were a small or medium sized private company, then seller notes and/or earnouts are a more feasible solution.

Question

Assume that Buyers and the board of directors of a Target company cannot agree on price for a possible LBO.   If the Target is a public company (with a diverse set of shareholders), it would be difficult to bridge the gap on value with a seller note and/or earn-out.  If the Target were a small or medium sized private company, then seller notes and/or earnouts are a more feasible solution.

BlackTom AI · Accepted Answer

The question presents a scenario about negotiating a price for a potential LBO between Buyers and a Target company's board, considering whether the Target is public versus private in terms of using seller notes or earn-outs.
Option 1: True. The statement asserts that if the Target is a public company with a diverse set of shareholders, bridging the price gap with a seller note or an earn-out would be difficult, whereas for a small or medium-sized private company, seller notes and/or earn-outs are more feasible. In public companies, the presence of many shareholders and the need to treat all holders fairly tends to limit the effectiveness of seller financing structures like seller notes or large earn-outs, because payout timing, alignment of incentives, and governance concerns can be impractical and hard to enforce across a dispersed ownership base. Conversely, privately held SMEs have fewer shareholders and more concentrated ownership, making it easier to negotiate bespoke financing arrangements such as seller notes or earn-outs that align incentives between the seller and buyer, and to structure terms without broad market-price implications. This distinction is a common consideration in leveraged buyouts and M&A financing literature.
Option 2: False. If this alternative were true, it would claim that the public company scenario is just as amenable to seller notes or earn-outs as the private SME scenario, or that public status does not inherently complicate such financing mechanisms. In reality, the dispersed ownership and fiduciary duties to a large group of shareholders in public firms generally make highly contingent payment structures and post-closing governance arrangements harder to implement, increasing the likelihood that debt-like or contingent pay structures are rejected or significantly constrained by market and regulatory expectations. Therefore, this option misstates the comparative feasibility and would be inconsistent with typical M&A practice in public versus private targets.
The reasoning above highlights why public-company targets often pose obstacles for seller financing schemes, while private, smaller targets can more readily accommodate seller notes and earn-outs as part of an LBO financing package, explaining the intended distinction in the statement.

SP25_FIN_622_2154 Final Exam - MBAs

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