What is an Earn-Out?
What is an Earn-Out?
Earn-outs are part of the consideration for your shares or business that is paid to you after completion (say one or two years) once certain agreed targets have been achieved.
Vendors have one idea of the price of their business, whereas Purchasers have a different value.
The reasons for the difference in value can be many but earn-outs are commonly used where the Purchaser sees the Vendor and the business as the same thing. Other situations may occur where there is a concentration of turnover in your top five customers or key suppliers or issues about management structures and employees.
Earn-outs can be extremely difficult to negotiate. There is naturally a temptation for both sides to adjust the profits to suit themselves. The acquirer may seek to impose excessive management charges against the company or seek to use it as a training ground for employees.
Bear in mind though that in the negotiations to sell your business, you may end up working for those persons with whom you were negotiating
Risk to the Vendor
In most deals the Vendor will have parted with his or her shares and has therefore lost the ownership of their business. The risk of achieving the earn-out is with the Vendor and the Purchaser will get most of the reward if the business is successful.
Periods of earn-out can vary but obviously the longer the period the greater the risk of (a) achieving the earn-out figure and (b) the ability of the Purchaser to make the payments.
Indeed the Purchaser itself may be taken over and the ability to reach the earn-out targets effected.
Earn-outs can be defined as the achievement of various targets whether that be sales revenue, profitability or cash generation. The simpler earn-out arrangements will be defined in relation to turnover where there is less temptation to adjust the target to suit Purchasers and Vendors.
However, the fundamental problem with earn-outs is that there may be a conflict with the desire of the Vendor to maximise profits over the period of the earn-out whereas this may not be consistent with the Purchaser’s plan to ensure integration as fully as possible in order to realise the anticipated benefits of the acquisition.
Once the Vendor has sold his or her shares their status in the company will have changed and this may be hard for him or her to take. It is no longer your business. In my experience, your interest wanes and prejudices the ability to achieve the earn-out target whatever that may be.
Call to Action
If you believe that there may be a gap between the two values, then please contact me, Andrew Watkin, at Assynt Corporate Finance Limited on 07860 898452 or email@example.com.
One of the things that I can do for you is to review with you is the value of the business. You can decide what to review and it might include, amongst other things, a review your business sector; a summary of the merger and acquisition activity in the sector; examination of recent transactions and likely acquirers of your business and a look at the weaknesses of your business to an outsider.
The benefit of this review would be that you could see in more detail the options available to you for the exit of your business so that you are then in the best position to minimise the amount that may be payable under an earn-out arrangement.
I look forward to hearing from you.
The information contained in this briefing is based on information available as at the date posted and may be subject to amendment. It is written as a general guide and is not a substitute for professional advice. You are strongly recommended to obtain specific professional advice from us before you take any action. No responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this briefing can be accepted by Assynt Corporate Limited or its employees.