Earnouts: Creating Confusion or Promoting Prosperity?

Earnouts Prosperity

Earnouts, although palatable in principle, may be complex in structure, difficult to define, and subject to unintended consequences. Thus, the gut reaction of most investment bankers to the proposed use of earnouts as an instrument to close transactions is unequivocally: “Don’t use them!” This declaration will more than likely be superseded by a full disclosure of the realities of the private capital marketplace. Earnouts are used every day in middle market mergers and acquisitions (M&A) transactions, and under the direction of an experienced M&A Team, properly structured earnouts provide motivated buyers and sellers with a viable solution to otherwise “dead deals.”

An earnout tends to be most impactful when it is used to:

  1. Provide Measurable Incentives – motivate sellers to be growth-focused post-closing; retain key employees; acquire new customers; renew contracts
  2. Align the Needs of Both Parties – reconcile value differences – historical versus projected financial performance
  3. Mitigate Risk – assure future earnings/growth; address uncertainties
Buyers and sellers have to be flexible throughout the negotiation process; relying on their M&A Team for guidance and experience to facilitate the design of an achievable earnout.