Almost every Financial Services M&A transaction references recurring revenue in some way.
More often than not, the entire consideration structure is based on recurring revenue – the overall consideration is usually a multiple of it, and where there are deferred consideration instalments, these are adjustable depending on post-completion recurring revenue performance.
It is therefore essential that buyers and sellers are not only clear on what will be captured within this concept, but also how it will be factored into the legal documents.
What is recurring revenue in its basic form?
Those involved in the Financial Services sector may have a different name for recurring revenue – be that OAC, repeatable revenue or otherwise – but essentially these all relate to the portion of a business’ revenue that is stable, predictable, and regularly generated over time, usually relating to the provision of ongoing advisory services.
Any income of a one-off or irregular nature, such as initial fees and commissions would be excluded from the concept.
Buyers like the recurring revenue as it is shows a steady flow of turnover, and sellers like it as it is an easily measurable metric to track their exit.
Value is in the drafting
This all sounds great in principle, but issues start arising when the legal documents are drafted, in particular when discussing how adjustments are made to any deferred consideration payments.
These are ultimately commercial decisions to make, but there are a few issues that frequently arise when solicitors are negotiating the legals:
Which clients will be captured?
At the point a transaction completes, there will be a suite of clients who are engaged by the business and who generate recurring revenue.
Where adjustable consideration is payable following completion, though, whose recurring revenue will you take into account?
Buyers will likely want the consideration to be linked to only clients in place at completion, but sellers may want it linked to a wider array of clients – whether that is clients they introduce post-completion, clients who are successors/beneficiaries of existing clients, or clients generally no matter when they are engaged with the business.
What business will be captured?
Similarly, at completion of the transaction recurring revenue will link to business that has been written at that point – but will new business written following completion be factored into any deferred consideration calculations?
How to treat post-completion actions that impact recurring revenue?
It is very rare that buyers will maintain the status quo in every respect following completion.
They may want to implement changes to the business, whether that is changing the fee structure applicable to clients, the scope of services provided, or otherwise.
Any such changes will likely impact the recurring revenue that is actually received, and therefore the parties need to agree how this will in turn impact the deferred consideration calculations.
Final Thoughts
It’s always worth parties to a proposed transaction refining how recurring revenue is to be dealt with as soon as possible, even at the heads of terms stage.
If everything to do with recurring revenue can be resolved early in a transaction cycle, a smoother process overall will likely follow.
For professional advice and drafting, contact us today.
