Payments over time & deferred consideration — Risk-Adjusted Yield.

Every dollar not wired at closing falls into one of three categories. Each carries a distinct risk profile. Time Value of Money turns deferred dollars into something less than face value — and the AFR compliance rule turns below-market note rates into a tax penalty.

§ 01 · The three deferred-payment vehiclesProbability profile of each.

Seller Note (Fixed Deferred). ~90% probability. Typical range 10–30% of TEV. Key risk: credit plus subordination. The amount is fixed; receipt is subject to payment blockage and bank-priority constraints.

Earnout (Variable Deferred). ~50% baseline probability. Typical range 10–30% of TEV. Key risk: performance plus Control Trap. Not owed until earned — and metrics can be manipulated by buyer expense loading.

Holdback / Escrow (Protective Deferred). ~95% probability. Typical range 5–20% of TEV. Key risk: indemnification claims. Technically the seller's money but sequestered to protect the buyer against undisclosed liabilities.

Probability ratings reflect baseline collection. Well-structured instruments with strong protections (security agreements, specific negative covenants, exclusive remedy clauses) can shift these significantly upward — converting a 50% baseline earnout into an 85% "Defensible Earnout."

§ 02 · Seller Note economics — pricing the subordinationMezzanine-level yield required.

Interest rates. Must be calibrated to risk. In 2026, rates below 7% subsidize the buyer. Proper Mezzanine Pricing dictates 7–9% yields.

PIK (Payment-in-Kind). Structure where interest is added to principal rather than paid in cash. Compounds risk: seller exposure grows over time without liquidity. Demand a rate premium (+1–2%) when accepting PIK.

Balloon payments. Notes structured with long amortization (10 years) but short maturity (5 years) rely on the buyer's refinancing ability. If credit markets freeze at maturity, the balloon defaults.

The "Hope Note." A seller note without a security agreement (UCC-1 / Stock Pledge) is unsecured debt. In bankruptcy it ranks equally with trade vendors and rarely recovers value.

§ 03 · Earnout and Holdback architectureVariable plus protective.

Earnouts are contingent assets — not owed until earned. The variables that determine whether the earnout is a "Bonus" or a "Bribe": metric selection (Revenue is preferred at 65% market usage; EBITDA introduces accounting risk where buyers can load expenses), and operational control (the "Control Trap" — without Specific Negative Covenants, the buyer can starve the business to avoid payout).

Protective Holdbacks (Escrow). Standard general holdbacks last 12–18 months for general reps, 3–7 years for tax reps, indefinite for fundamental reps (cap table, title). Deductible Basket — seller pays only damages exceeding a threshold (seller-friendly). Tipping Basket — once threshold is hit, seller pays from dollar one (buyer-friendly). Working Capital True-Ups — 90-day post-close adjustment reconciling actual working capital against an agreed target. RWI Impact — Reps & Warranties Insurance creates a "Public Company Style" exit, often reducing escrow to 0.5–1.0% on deals over $20M.

§ 04 · Economic reality — the Sanity checkTime Value of Money discounting.

A dollar received in Year 5 is not worth a dollar today. Deferred payments must be discounted to present value using a rate reflecting their risk. Seller Notes: 8–10% discount rate (subordinated debt). Earnouts: 15–20% discount rate (high uncertainty, buyer control). Rollover Equity: 15–25% discount rate (illiquidity premium).

Example. A $1M earnout payable in 3 years discounted at 18% has present value of approximately $609K — a 39% haircut versus the headline figure. Sellers comparing offers must compute risk-adjusted PV, not just total notional value. Inflationary erosion compounds the math — a $500K balloon payment due in 5 years buys roughly $430K of 2026 value at 3% inflation.

§ 05 · Tax implications and the five-step Risk-Adjusted Yield calculationThe seller's true financial North Star.

Installment Sale Treatment (IRC §453). The "Tax Shock Absorber." Sellers recognize capital gains only as principal payments are received on the seller note — spreading liability across multiple tax years and potentially keeping income in lower brackets. Available for the seller-note portion but forfeited in 100% all-cash deals.

Interest income taxation. Interest received on seller notes is taxed at ordinary income rates (up to 37% federal), not capital gains. Each monthly payment is split between principal (capital gains) and interest (ordinary income) based on the amortization schedule.

Imputed Interest (AFR Compliance). The IRS requires a minimum interest rate equal to the Applicable Federal Rate (AFR) on seller notes. If a note carries below-AFR interest, the IRS reclassifies a portion of principal as taxable interest income — penalizing the seller. Always check current AFR (published monthly) before setting note rates.

The five-step Risk-Adjusted Yield calculation. 1. Probability-weight each tranche (Cash 100%, Escrow 95%, Note 90%, Rollover 70%, Earnout 50%). 2. Apply discount rate to compute PV of each deferred component. 3. Subtract debt and escrow (Net Wire = Purchase Price minus Debt minus Escrow plus or minus WC Adjustment). 4. Apply tax filter (convert to After-Tax Net, factoring in installment treatment, ordinary vs capital, state tax). 5. Compare to alternatives — a deferred-heavy offer often nets less than a Clean Break at one band lower headline.

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