The earn-out is an agreement between a buyer and a seller about the payment structure of (part of) the purchase price for a company. The structure means that the seller must ‘earn’ part of the purchase price based on pre-agreed performance indicators of the company. The agreements on the payment structure usually have a term between 1 and 3 years and often cover 10% to 50% of the purchase price. The performance indicators can be linked to targets on turnover, sales or production numbers, gross margin, cost structure and profitability or a combination.
In the (full) sale of a company, the earn-out structure is not the first thing pulled out of the hat to marry price perception between the buyer and seller.
If parties want to come to a deal while there is no agreement (yet) on the height of the purchase price, the earn-out is often the last possible solution to bridge the gap. After all, the buyer has the certainty that he will not pay too much if future performance proves disappointing and can thus convince himself and his supporters and financiers. The seller only has to keep his promises to get his purchase price paid.
The earn-out structure means that the seller cannot be sure if he or she will receive the full amount when agreeing to the deal. Does that mean you should never agree to an earn-out construction? Sometimes there is no other choice. There are some key point sellers should take into consideration when making the earn-out construction. To ensure that the seller has a grounded sense of security going into the future:
- a) Ask yourself whether you are also satisfied with the deal if you end up not getting paid a part;
- b) Is the earn-out realistic and can the seller sufficiently influence the measurable feasibility?
- c) Is it in the interest of both the buyer and the seller to meet the conditions for payment?
- d) The development of the scheme requires (legal) expertise and should be drawn up by an experienced lawyer.
Keep these points in mind and perhaps in a few years, you and the buyer will drink a good glass of champagne at the end of the earn-out period. Want to know more about the earn-out or how Marktlink can be of service? Get in contact with us.