“WHEN THE PRICE IS NOT THE PRICE” HOW DEAL TERMS CHANGE VALUATION
May 20, 2026
THE HEADLINE NEWS
When it comes to private investments, be it venture capital rounds, minority private equity investments, majority investments, or full buyouts, the most asked question, from anyone and everyone, is “What was the valuation?”. In a world that lacks transparency, pricing information is the dearest commodity. But what many observers fail to fully appreciate is that “the price” which is most often expressed as a multiple of revenue or a multiple of EBITDA, rarely tells the full story and at times can be misleading. This is because private equity investments and M&A transactions very often have complex deal structures that include various triggers that can significantly impact deal economics depending on certain outcomes.
These various structure components are the grease that gets deals done and bridges the gaps between buyers and sellers. The valuation multiple, either revenue or EBITDA, is best viewed as the end of the process and not the beginning, as it is the product of deal structure and valuation drivers/detractors specific to a given company. The “multiple” is what everyone is always asking for; “Company XYZ just raised $50M at a 15x EBITDA valuation!”. What is not often discussed are the other components of the investment that can add or subtract to that multiple, collectively “deal structure”. Deal structure items can include payout preferences, earn-outs, dividends, warrants, escrows, and risk specific indemnifications. These can be used to address downside risk protection, cash flow to the investor, investment return targets and/or reduced dilution for the existing shareholders. Best to think about these as tools in a toolbox that can be applied to address the desires of the investors and the company.
The headline news may be “Company XYZ just raised $50M at a 15x EBITDA valuation!”, but the effective valuation upon a future liquidity event or exit could be much different due to the deal structure, and most likely unknown at the time of the investment. This is because the various other factors and triggers will not be known until a future date. On the surface, the headline news is correct at the time of the investment, but the actual effective valuation at a point in the future could be very different.
EVERYTHING HAS A PRICE
Risk is at the heart of business. Without risk there is no reward, “no free lunch” as the academics like to say. This risk profile creates a natural tension between company founders who are seeking to sell equity at the highest possible price and investors who want to ensure they are not overpaying. Entrepreneurs by nature are optimists, they must be to be successful. Institutional investors, like private equity firms, are seeking to balance risk with reward, with some being more conservative than others. One mechanism to bridge the gap and remove the tension is a “preference” provision, which is often applied in the case of minority investments; where the investor owns less than 50% and thus does not have control of the company. The preference entitles the investor to be paid out upon a liquidity event (i.e., the sale of the company) before any other shareholders. The preference is a multiple of the invested amount; common preferences are 1 to 2 times the amount invested but can go higher.
Consider the following example and its impact on the valuation. Company XYZ raised $50M from ABC Capital at a “pre-money” valuation of $200M, resulting in ABC Capital owning 20% of the Company based on the “post-money” valuation of $250M ($200M+$50M). The pre-money valuation was 15x the trailing twelve-month EBITDA of $13.3M. As part of the investment, ABC Capital negotiated a 2.5x preference, which means at minimum they get paid $125M ($50M x 2.5) upon a liquidity event (assuming there is enough money to pay this amount, if not they get all the proceeds). If their 20% ownership is worth more than $125M, they get the higher amount. The breakeven exit value—where their 20% stake exceeds the $125M preference—is $625M ($125M/20%=$625M).
As previously mentioned, ABC Capital gets paid first, before the other shareholders. The amount of money they will get paid depends on the value at exit. In our example above, Company XYZ has a solid outcome but below the growth case envisioned by the founder. The company is sold for $400M five years in the future, a nice increase from when the investment was made. At $400M ABC Capital’s 20% is worth $80M, well below their preference. Lucky for them, they have the preference to fall back on; and are paid $125M. The $125M is 31.3% of the total value of $400M. At the time of exit, ABC Capital effectively owns 31.3% of the company for their $50M. This brings the company’s initial post-money valuation down from $250M to $160M ($50M/31.3%) and the pre-money valuation down to $110M ($160M-$50M). At $110M the EBITDA multiple drops to 8.3x ($110M/$13.3M). At the time the investment was made the headline news of a 15x multiple was correct, but upon exit it dropped to 8.3x due to the impact of the deal structure. A very significant difference.
Why would anyone do this deal, is this fair? The short answer is “yes” this is a fair deal. Preferences and other structure elements are used to bridge gaps in valuations and differences between investors and founder’s goals and risk profiles. Consider the case of Company XYZ above. At the time of the $50M investment the company was growing fast due to a successful launch of a new product. This new product was over 30% of the revenue of the company and represented 70% of the top line growth. The founder was very bullish about the future of this product and had forecasted continued aggressive growth. This concentration risk raised concerns during ABC Capital’s due diligence. To hedge this risk, they proposed a valuation of 11x EBITDA. Both the investor and the founder believed in the future of the company, that they would be good partners and that the investor would bring significant value to the table. The only thing left to solve for was the gap in valuation expectations. The founder was very optimistic about the business and desired the minimum amount of equity dilution possible. He proposed an EBITDA multiple of 15. To bridge the valuation gap between 11 and 15, the investor was willing to agree to the 15 multiple, provided they receive a 2.5 liquidation preference. The founder subsequently agreed. Both founder and investor were aligned and incentivized to maximize the long-term value of the business, and each party would participate in the future value of the business in a manner that aligned to their respective objectives and risk profiles.
ALIGNMENT BEATS OPTICS
In the health and wellness industry, eye-popping valuation multiples get a lot of attentionfrankly, too much attention. These headlines, while interesting and informative, are a distraction to founders and their boards, especially for those parties that have not raised institutional capital or sold a business. Solely focusing on this narrow metric can create unrealistic expectations that can cause friction and uncertainty come deal time. The “preference story” above is illustrative of the impact that deal structure can have on valuation. In reality, transactions are often much more nuanced and complex. Structure elements such as earn-outs, warrants, management incentive programs, seller’s notes, escrows, working capital adjustments and indemnifications can all play a role in the final effective valuation.
The tension between investors on the one hand and founders on the other hand is healthy and a natural outcome of business. Successful transactions are based on candid acknowledgement and respect for each party’s views, perspectives, and objectives. The enterprise value, expressed as a multiple of EBITDA or revenue, “the price,” isthe final expression of the deal. The other structure elements: preferences, earn-outs, escrows, etc., can each play a role in addressing various differences between investors and founders. For example, they can be used to provide the founder with greater upside in the case of outsized performance, they can be used to provide downside protection for an investor that is concerned with risk, or they can be blended to meet a series of outcomes, concerns and goals. They are the bridge that gets deals done. The give and take of the various drivers ultimately come to rest as the valuation multiple – both at closing and at exit.
Coil the Spring – be prepared
With complete information everything makes sense. Unfortunately, it is very rare, if not impossible. When it comes to private investments, be it venture capital rounds, minority private equity investments or buyouts achieving maximum valuation is always the objective. However, the best outcome is often a deal that is mutually beneficial, aligns interests and meets the longterm objectives of all parties. Investors and founders are entering into a marriage that is difficult to exit. To an outsider it is challenging to understand why some work, and some don’t, the headline news does not tell the whole story. Institutional investors and strategic buyers have a formalized “mandate” that defines the various key elements they want in an investment including the balance of risk and reward. Having done many transactions they have developed and refined deal structures that they are comfortable using to address various aspects of their mandate and founders’ expectations. Founders have spent considerable time, energy, and effort on growing their business but perhaps much less time on what they are seeking from a financial partner or from a sales process. When it comes time for a transaction, a seller is best served by contemplating what they are seeking from the transaction in the long term and taking a step back to honestly assess the future prospects of the business. This will help ensure that discussions and decisions are well informed and deal structures are fit for purpose. Prioritizing the headline valuation of other deals as a key driver is a trap worth avoiding
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