There’s an interesting article published recently about “earn-outs,” by merger-and-acquisition guru Scott Lochner.
What’s an Earn-Out?
According to Lochner, “If there is disagreement about the business value of a company whose assets or shares of stock are being potentially purchased and sold in an M&A transaction, it is common to include an “earn-out” provision as a portion of the purchase consideration.”
An “earn-out” is basically a payment for work and performance after a deal is closed. For example, if a seller believes the value of a company is $55 million or more and the buyer thinks it’s worth only $50 million, than the gap in purchase consideration is five million dollars.
That $5 million gap can be closed with an “earn-out,” or a contract that allows the seller to earn up to that $55 million or more if the business sold performs on an agreed target (financial or non-financial) over an agreed amount of time.
Benefits and Risks of an Earn-Out
Lochner argues that earn-outs can protect purchases who don’t want to overpay and sellers that don’t want to undervalue their business. The downside is they require very detailed contracts and can be risky if not completely thought out and executed properly. In any case, an earn-out might be just the clause to get you from maybe to a handshake.