As mentioned previously regarding earn-outs, these are common provisions that you will see from the buyer as a seller of your company as a way to compromise on the valuation. Let’s take a look at some examples:
In 2014, Alcoa purchased aerospace jet engine component maker Firth Rixson for $2.85 Billion. This included $2.35 billion in cash, $500 million in common stock, and an additional $150 million in a potential earn-out.
Notice here that the earn-out is a relatively small percentage of the price, 5.26% of the overall purchase price. There are several reasons for this. In larger deals, the buyer has access to detailed financial reporting and history from the company to be acquired. This means that buyers are taking more known risk and less unknown risk in the purchase. Second, Alcoa has cash on hand to make the purchase, so they have less constraints in terms of capital and are looking to put their cash to work to obtain an ROI.
Let’s look at the other end of the spectrum.
In August of 2018, Salem Communications purchased Just1Word for $300,000 in cash and up to another $100,000 in earn-out payments. Here, Just1Word is bible reader app that can be used with multiple languages, which fits nicely with Salem Communications web property assets. The earn-out payment is over two years and contingent upon hitting revenue benchmarks. Here, the earn-out in relation to the purchase price is much larger, 25%. The buyer here is taking on more risk with a smaller acquisition, with more unknowns, and so the 25% earn-out provides upside for the seller and lowers the risk for the buyer. Also, notice that the earn-out is based on revenue, not EBITDA. Revenue is a more appropriate measure because Just1Word is likely in the growth phrase, rather than profitability phase. Just1Word may have little chance of hitting EBITDA benchmarks.
Fogel & Potamianos LLP‘s General Counsel Group serves as outsourced general counsel to small and middle market companies, as well as high net worth individuals. Our Corporate Practice Group provides expertise in M&A dealmaking.
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