Proceeds from a sale flow through debt, transaction costs, preferences, escrow and earnouts before reaching each shareholder. The waterfall decides what a headline price is worth to you.
13 min read · Level 5
The distance between a headline acquisition price and a shareholder's closing payment is where a lot of disappointment lives, and I think investors should compute it before a sale rather than learning it from the closing statement. The arithmetic is not difficult; it is just rarely done in advance.
When a company is sold, the price announced is rarely what shareholders receive. A typical waterfall:
1 Repay debt 2 Pay transaction costs (advisers, lawyers) 3 Pay preferences, or allow preferred holders to convert 4 Distribute the remainder to shareholders 5 Hold back escrow; pay earnouts later if earned
A worked sale. A company sells for 60,000,000. It has 5,000,000 of debt and 2,000,000 of transaction costs. Preferred investors hold a 20,000,000 1x non-participating preference and own 40% of the company.
Sale price 60,000,000 Less debt -5,000,000 Less transaction costs -2,000,000 Net proceeds to equity 53,000,000
Preferred: greater of 20,000,000 or 40% x 53,000,000 = 21,200,000 They convert and take 21,200,000 Common receives 31,800,000
An angel owning 1% of the company receives 1% x 53,000,000 = 530,000.
Escrow. Buyers often hold back part of the price for a period, commonly 12 to 18 months, to cover claims under the warranties in the sale agreement. With 10% held in escrow, the angel receives 477,000 at closing and up to 53,000 later if no claims are made.
Earnouts. Part of the price may depend on the business hitting targets after the sale, and may never be paid.
Because investors often calculate their proceeds as ownership times headline price, and are then surprised by a smaller, later payment.
It also shows why the details of a sale agreement matter to every shareholder, not just the lead investors: escrow, warranties and earnouts all affect what and when you are paid.
Educational, not personalised financial advice. Nothing in the Investor Academy is a recommendation to buy, sell or hold anything — what is right for you depends on your own circumstances and the rules where you live.
Headline versus received for the same angel.
Calculation Amount Naive: 1% x 60,000,000 600,000 After debt and costs: 1% x 53,000,000 530,000 Paid at closing after 10% escrow 477,000 Paid later if no claims 53,000
The angel's cash at closing is about 80% of the naive figure (477,000 / 600,000). If part of the price had also been an earnout that was not achieved, the difference would have been larger.
Computing your proceeds as ownership percentage times the headline sale price, without subtracting debt, costs, preferences, escrow and conditional payments.
Find net proceeds available to shareholders.
For each preferred class, decide whether it takes its preference or converts, as in the term sheets lessons.
Apply your ownership to the relevant pool, common or as-converted.
Note what is paid immediately, what is held back, and what depends on future targets.
When a company you hold is being sold, or when estimating what a potential sale would return.
Do not assume every sale follows this order exactly. Specific agreements, share classes and local law determine the actual waterfall.
Studies of private acquisition terms published by legal and M&A advisory firms, such as annual deal terms studies, have reported that escrow or holdback arrangements are common in private company sales, often around 10% of the price for 12 to 18 months, and that earnouts appear in a meaningful share of deals and are a frequent source of later disputes.
Treat escrow as delayed and uncertain, and earnouts as possible rather than probable, when estimating proceeds.
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