M&A: In a Sale Transaction, an Earn-Out May Reduce Seller’s Proceeds

An “earn out” is an agreement in the Purchase and Sale Agreement that part of the purchase price will be dependent upon the Buyer being able to earn a certain amount of money after the sale, usually defined as either revenue, gross profit, or net profit.  So, an agreement may say “Buyer will pay $10MM for the business, but $1MM will be conditioned upon the Buyer being able to earn at least $5MM in revenue in the next fiscal year.”  Or it may say, “Buyer will pay $10MM for the business at closing, plus an additional 5% of sales generated in the 12 months following the close of the purchase.”  Or perhaps, “Buyer will pay $10MM for the business at closing, plus an additional 10% of EBITDA generated in the 12 months following the close of the purchase.”

Earn-outs can be very complicated and risky for a Seller.  The Seller may be counting on this money as part of the purchase price, but there is significant risk that they will not receive part or all of it. This is, of course, because the Buyer now controls the ability of the business to earn the threshold for payment of the earn-out.  And even if the Buyer manages the business well, the market itself may let the Seller down and prevent the business from earning what it needs to earn to justify the earn-out payment.

Traversi & Company can guide you through the often complicated and challenging earn-out conundrum to a sound result!

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