🧭 Dojo Compass
Module: Finance, Risk Management and Long-Term Resilience
Focus Area: Financial Management
Key Article Point
One of the most common reasons private investment transactions fail is surprisingly simple: the buyer and seller have different views about the future.
The seller sees a business with significant growth potential and wants today’s valuation to reflect tomorrow’s success. The investor sees uncertainty and does not want to pay today for performance that may never materialize.
Both may be rational.
The problem is that conventional valuation negotiations often force them into a binary choice: agree on a number or walk away.
A better approach is sometimes to stop trying to eliminate the disagreement.
Instead, structure the transaction so that the economic consequences of the uncertainty are shared.
🎯 Key Challenge
Valuation is fundamentally an exercise in making assumptions about the future.
An investor may believe that a company’s EBITDA will grow from $10 million to $15 million over three years. The owner may believe it will reach $20 million.
If the business is valued at a multiple of future EBITDA, these different assumptions can produce dramatically different valuations.
The negotiation can quickly become:
Seller: “The company is worth $150 million.”
Investor: “We think it is worth $100 million.”
Seller: “You are undervaluing the growth.”
Investor: “You are asking us to pay for growth that has not happened.”
Neither party necessarily has better information. They simply have different exposures to future risk.
This is where deal structuring becomes important.
Instead of asking:
“What is the correct valuation today?”
the parties can ask:
“How can we structure the transaction so that the final economic outcome reflects what actually happens?”
That changes valuation from a potentially zero-sum argument into a risk-allocation exercise.
🥋 Dojo Solution
Replace Forecast Disagreement with Performance-Based Risk Sharing
The central principle is straightforward:
If the parties cannot agree about the future, create terms that allow future performance to determine part of the economic outcome.
There are several ways to do this.
The appropriate mechanism depends on the nature of the uncertainty, the amount of control each party has over the relevant variables and how long it will take for the uncertainty to resolve.
1. Earn-Outs: Pay More if the Business Delivers
The most familiar mechanism is an earn-out.
Instead of paying the entire negotiated price at closing, part of the consideration becomes payable if the company achieves agreed targets.
For example:
- $50 million paid at closing;
- another $10 million if revenue reaches $40 million;
- another $10 million if EBITDA reaches $8 million.
The seller receives the possibility of a $70 million total valuation, while the buyer does not have to pay the additional $20 million unless the business actually delivers the agreed performance.
Earn-outs are particularly useful where the disagreement concerns growth.
But they must be designed carefully. If the buyer controls the business after closing, the seller may argue that poor performance resulted from decisions made by the buyer rather than the underlying business.
That means the formula should distinguish between business performance risk and post-closing management decisions.
2. Milestone Payments: Use Operational Events Rather Than Financial Results
Not every future outcome is best measured through revenue or EBITDA.
In technology, healthcare, manufacturing, life sciences and other sectors, value may depend on operational milestones.
Payment could therefore be linked to:
- regulatory approval;
- product launch;
- customer contract execution;
- production capacity;
- certification;
- intellectual-property milestones;
- successful completion of development;
- customer retention;
- geographic expansion.
This can be particularly useful when financial performance is affected by many variables outside the seller’s control.
The key question is:
What observable event would demonstrate that the uncertain part of the investment thesis has actually become real?
That event can become the payment trigger.
3. Seller Notes: Share Financing and Business Risk
A seller note can also help bridge a valuation gap.
Suppose the seller wants $20 million more than the buyer is prepared to pay at closing.
Rather than simply walking away, the buyer could pay the lower amount in cash and have the seller finance part of the remaining consideration through a subordinated note.
The seller therefore remains economically exposed to the business after closing, while the buyer reduces the amount of capital it has to commit immediately.
This mechanism does something subtle: it gives the seller an opportunity to receive the higher economic value it believes the company deserves, while requiring the seller to retain some exposure to the business risk underlying that valuation.
It can therefore be particularly useful when the buyer believes the business is sound but is concerned about paying too much upfront.
4. Rollover Equity: Let the Seller Participate in the Upside
Sometimes the best way to resolve a valuation disagreement is not to calculate the seller’s future upside—it is to let the seller keep participating in it.
For example, rather than selling 100% of the company for a disputed valuation, the seller might receive:
- cash for 70% of the agreed transaction value; and
- equity in the acquiring company or post-transaction entity for the remaining economic interest.
The seller therefore participates in future value creation.
This is particularly powerful where both parties believe the company has substantial upside but disagree about how much of that upside should be recognized today.
Instead of arguing about whether the business is worth $100 million or $140 million, the parties can effectively say:
“Let’s transact at a mutually acceptable current value and allow future value creation to determine the rest.”
5. Ratchets: Share the Consequences of Future Performance
A ratchet can adjust the economic position of one or more parties depending on future performance.
For example, an investor may receive additional equity if EBITDA falls below a threshold, while the founders may receive additional equity if the company significantly exceeds its growth targets.
Ratchets can be useful in growth investments where the parties have very different expectations about future performance.
They should, however, be used sparingly. A complicated ratchet can create a second negotiation hidden inside the first transaction.
6. Holdbacks and Escrow: Share Specific Risk
Not all valuation uncertainty is about growth.
Sometimes the buyer is worried about a specific potential liability:
- litigation;
- tax exposure;
- environmental liabilities;
- customer claims;
- regulatory issues;
- warranty problems.
Rather than discounting the entire valuation because of one uncertain risk, the parties can isolate it.
A portion of the purchase price can be placed in escrow or held back and released depending on whether the specified liability materializes.
This is an important principle:
Do not use a blanket valuation discount to price a risk that can be separately identified and measured.
Isolating the risk can preserve more value for both parties.
7. Price Adjustment Mechanisms: Let Closing Data Determine the Final Price
Another useful technique is to establish a preliminary valuation and then adjust the final consideration based on objectively measurable conditions at closing.
Common variables include:
- working capital;
- net debt;
- cash;
- inventory;
- normalized EBITDA;
- customer concentration;
- other agreed balance-sheet or operating measures.
The benefit is that the parties do not need to predict everything perfectly months before closing.
They establish the economic framework in advance and allow actual closing conditions to determine the final adjustment.
🏗️ Putting It into Practice
Step 1. Identify the Actual Disagreement
Do not begin by asking which mechanism to use.
First identify what the parties actually disagree about.
Is it:
- market growth?
- customer retention?
- EBITDA margins?
- regulatory approval?
- integration?
- working capital?
- a specific contingent liability?
- the seller’s forecast?
A risk-sharing mechanism should address a specific uncertainty, not simply be added because it sounds sophisticated.
Step 2. Determine Who Controls the Risk
This is one of the most important design questions.
If the seller controls the relevant variable, a performance-based payment may be appropriate.
If the buyer controls it after closing, an earn-out based on that variable may create disputes.
If neither party controls it—such as commodity prices, regulatory changes or macroeconomic conditions—the formula may need a different structure.
Step 3. Select the Appropriate Mechanism
A useful SME decision tree is:
| Uncertainty | Potential Tool |
|---|---|
| Future revenue/EBITDA | Earn-out |
| Specific operational achievement | Milestone payment |
| Seller believes valuation is understated | Rollover equity |
| Buyer wants seller to retain exposure | Seller note |
| Specific contingent liability | Escrow/holdback |
| Closing financial position | Price adjustment |
| Large uncertainty in growth investment | Ratchet |
| Multiple uncertainties | Combination |
The objective is not maximum complexity.
It is precise allocation of risk.
Step 4. Keep the Formula Simple
A formula should ideally be understandable without an accountant or lawyer standing beside it.
For example:
“Seller receives $5 million if EBITDA for FY2028 exceeds $12 million.”
is easier to administer than a formula involving numerous adjustments, accounting policies, exclusions, exceptional items and discretionary management decisions.
Complexity creates ambiguity.
Ambiguity creates disputes.
Disputes destroy much of the value the risk-sharing structure was intended to create.
Step 5. Protect the Measurement Process
The parties should agree in advance on:
- accounting principles;
- measurement periods;
- definitions;
- information rights;
- audit rights;
- treatment of acquisitions and disposals;
- extraordinary events;
- changes in accounting policy;
- dispute resolution.
This is particularly important for earn-outs because the buyer may control the company’s post-closing operations.
The seller needs sufficient protection to ensure that the buyer cannot deliberately or inadvertently prevent a payment from becoming due.
The buyer, meanwhile, needs protection against the seller manipulating results before closing or taking actions designed primarily to maximize the contingent payment.
📌 Key Takeaways
- A valuation disagreement does not necessarily mean the deal is impossible.
- Parties with different forecasts can sometimes agree on a mechanism rather than a single forecast.
- Earn-outs are only one form of risk sharing.
- Milestones, seller notes, rollover equity, ratchets, escrow and price adjustments can address different types of uncertainty.
- The best mechanism isolates the specific risk causing the disagreement.
- Always ask who controls the variable on which the formula depends.
- Keep formulas simple, objective and auditable.
- Define accounting and measurement rules before signing.
- Consider the time horizon carefully: the further into the future the formula extends, the more opportunities there are for circumstances and incentives to change.
- Risk sharing is not about making everyone equally exposed to everything. It is about allocating each material uncertainty to the party best positioned to bear or influence it.
🌿 Reflection
A valuation negotiation often assumes that the parties need to agree about the future before they can agree about the present.
They do not.
The future is inherently uncertain. An investor may be right that the business will grow slowly. An owner may be right that it will grow rapidly. Neither can know with certainty.
The transaction therefore does not necessarily need to resolve the disagreement.
It can encode the disagreement into the transaction itself.
The buyer can pay less upfront and more if the upside materializes. The seller can accept less cash today while retaining equity. A contingent liability can be isolated rather than used to discount the entire company. A milestone can replace an argument about probability.
This leads to a broader principle for dealmaking:
When parties disagree about risk, the solution is not always to find a better forecast. Sometimes it is to design a better allocation mechanism.
Good deal structuring turns uncertainty from something that prevents transactions into something that can be priced, shared and managed.
That is particularly valuable for SMEs, where one failed transaction can consume months of management time and potentially close an important strategic window.
⚔️ Dojo Mission
Take a transaction where buyer and seller disagree about valuation.
Write down the three biggest areas of disagreement.
For each one, complete this five-part test:
1. What is uncertain?
What future event or outcome are the parties actually arguing about?
2. Who controls it?
Buyer, seller, both, or neither?
3. How can it be measured?
What objective evidence would demonstrate what actually happened?
4. What mechanism could share the risk?
Earn-out, milestone, seller note, rollover equity, ratchet, escrow, price adjustment—or another structure?
5. What would a fair outcome look like?
What should each party receive if the outcome is better, equal to, or worse than expected?
Then ask the most important question:
Can we stop arguing about what the business will be worth and instead design terms that allow actual performance to determine part of the answer?
If the answer is yes, you may have found a way to turn a valuation dispute into a transaction.
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