Who is on the hook?
Earn-out agreements are useful but contentious tools in M&A transactions to bridge disagreements. In an earn-out, the seller agrees that a portion of the deal consideration will be contingent upon the future performance of the company.
Sellers must participate in estimating their earn-out expectations and in due diligence of the likelihood of collection. The possibility of payout is increased by:
- Confirm buyer’s creditworthiness and ability to run the business.
- Verify the buyer’s plan for operating the business.
- Ensure the formula for earn-out payments is clearly specified and that you have the right to examine financial information related to the earn-outs.
- Understand buyer’s plans that may endanger key customer and supplier relationships, employee retention or the company’s cash flow.
- Make certain the earn-outs are beneficial to the buyer.
- The earn-out period should be less than two years.
At the end of the day, getting paid depends on the reputation and character of the buyer. Experienced M&A professionals will ensure the sellers understand the potential reduction of earn-out compensation from buyers’ post deal remorse, misinterpretation of provisions, “management” or possible manipulation of financial results.