Earn-out arrangements often feature heavily in the sales and acquisition space.
Sometimes this might be because a buyer is a multinational corporation acquiring a local business, who is dependent on the existing management to continue to operate the business. But often times it might simply be an approach being used by a buyer to share the risk of transition to new management for a period following the sale.
But whatever the reason, it is important for a seller to bear in mind that there are a number of potential risks in accepting an earn-out arrangement, so the details must be very clearly thought out, and the seller should ensure that there is some commercial aspect of the arrangement that provides enough up-side as a trade-off for the extra risks that they are taking on.
If you have decided to use an earn-out arrangement, see below for our top 4 tips:
1. Carefully work through how the financial targets will work
Make sure you are clear about the formulas that are to be used, and the control that you will have over elements that may impact the end result – for example if targets relate to net figures, then be clear on what costs can and can’t be offset, and who has control over those costs.
Test the formula against a variety of different possible outcomes, for example by running the formula against various different stages in the history of the business, to check that your return in different circumstances will be what you had intended.
2. Consider the extent of integration when assessing the earn-out targets
How will the business operate post completion? Will it continue to operate as a separate business with minimum integration or will it be significantly integrated with a view to achieve synergistic savings? Once you know the extent of integration you can start thinking about the reasonableness of targets to be achieved in respect of the earn-outs.
3. Assess the protection of your interests during the earn-out period
Whilst a purchaser may be very clear on what financial targets they expect an acquired business to achieve, it is important for sellers to make sure their interests are adequately protected during the earn-out period in respect of a number of key areas of the business, for example:
- commitment from the purchaser to provide adequate debt and equity funding to the business
- retention and replacement of key staff and other resources you may be dependent on to achieve the financial targets
- strategic direction and business model of the business
- treatment of certain expenses and one-off costs arising as a result of the acquisition or integration
Don’t get caught out on not making your earn-out because of changes that have been made to the business by a purchaser that you did not expect.
4. Get security where appropriate
Consider whether it is appropriate to take security over the earn-out payment. This approach can also help to create another enforcement measure if the relationship happens to sour before the payments are fully made. There are lots of ways that this can be achieved – your advisers can help you to work through the options available and the various potential benefits of each approach.
Aspect Legal offers a number of services to assist businesses in sales and acquisitions.
If you are considering an acquisition or sale or if you have any tricky questions that you need a sounding board for – just give us a call on 02 8006 0830 or send an email through to us, and we will be in touch for a free discussion.
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