You have put years of hard work, including restless nights, into your company. And now you have an offer to purchase your company (perhaps from an international corporation with operations here in US, or a US based company looking to expand their portfolio). You have been negotiating on price with the buyer and seem to be at an impasse. At this crossroads, the seller suggests an earn-out provision.
What is an earn-out?An earn-out is a contractual provision which provides to the seller a bonus or percentage of earnings based on performance subsequent to the sale of the company.
Here is what the initial earnout provision might look like (more about these in another post):
This Earnout Agreement (“Agreement”) is entered into this __ day of ___, 20___, by and between _________ (“Seller”) and ___________ (“Buyer”).
Seller has sold to Buyer the Acquired Company pursuant to the Stock Purchase Agreement by and between Seller and Buyer (the “Purchase Agreement”).
The Purchase Agreement stipulates that a portion of the purchase price is to be calculated and paid as an earnout based on EBITDA generated by the Acquired Company over the Term.
What’s good about earn-outs? If a buyer and seller are close in value, but having difficulty landing on an agreement, an earnout can and often is a compromise solution which allows future performance to decide the issue on the price.
What’s not so good about earn-outs? Often buyers and sellers push off more difficult conversations about value when they are at opposite ends of the spectrum, which can and do turn into disputes and lawsuits down the line.
What should you do as a seller? Carefully review the earnout provisions with your advisory team (i.e., attorneys, accountants) before accepting any offer. As a general rule of thumb, ideally earn-outs should be a “bonus” for your company’s performance, as opposed to a large portion of the valuation. Typically none of the earn-out compensation is guaranteed.
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.
This blog is provided for general informational purposes only and no attorney-client relationship with Fogel & Potamianos LLP is created. By using the blog, you agree that the information on this blog does not constitute legal or other professional advice. The blog is not a substitute for obtaining legal advice regarding a potential matter from a qualified attorney licensed in your state.