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How to Blackout Earn Out Agreement

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Mergers and acquisitions often feature announcements like "Company A is acquiring Company B for ten million dollars," but this price can vary. Sometimes, it includes a contingent payout known as an earn-out. An earn-out is an agreement allowing the seller (or shareholders of Company B) to receive extra payments if the company achieves specific financial goals. For instance, while Company A may pay an initial ten million dollars for Company B, they might agree to pay an additional five hundred thousand dollars if Company B's net income exceeds two million dollars in the following year. Thus, the total payment could potentially exceed the initial purchase price based on performance outcomes.

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What are the different types of earnout arrangements?

Typically, the two types of earnout compensation are a right to fixed payments (guaranteed) and contingent payments (subject to achieving financial milestones).

What is an earnout in accounting?

An earnout is a contractual provision stating that the seller of a business is to obtain additional compensation in the future if the business achieves certain financial goals, which are usually stated as a percentage of gross sales or earnings.

What is an earnout agreement?

What Is an Earn-Out? An earn-out is a provision in an acquisition agreement (the agreement) that makes a portion of the purchase price for a target company or business (the business) payable to the seller of the business (the seller) based on the post-closing performance of the business.

How do you account for earnout payments?

The earnout is measured by present valuing the expected payment. The present value is recorded as either equity or as a liability. If the earnout is for a fixed dollar value, then the present value is recorded as a liability and measured at fair value going forward.

Are earnouts on the balance sheet?

Balance Sheet: Earn-Outs are recorded as Contingent Consideration, a Liability on the LE side. Income Statement: You record changes in the value of the Contingent Consideration here, i.e. if the probability of paying out the earn-out changes, you show it as a Loss or Gain here.

How do you structure an earnout agreement?

Earnout structures involve seven key elements: (1) the total/headline purchase price, (2) the % of total purchase price paid up front, (3) the contingent payment, (4) the earnout period, (5) the performance metrics, targets, and thresholds, (6) the measurement and payment methodology, and (7) the target/threshold and

What is an example of an earnout agreement?

For example, if the seller thinks the business is worth $100 million and the acquirer believes it is worth $70 million, they can agree on an initial price of $70 million and the remaining $30 million can form part of the earnout.

Are earn outs expensed?

Generally, an earn-out will be treated for tax purposes as part of the purchase price. However, if the selling shareholder will continue to provide services to the company, it is possible that the amount will be considered compensation for services.

What is an example of an earnout provision?

Earnouts are often used to bridge pricing gaps between buyer and seller. For example, the seller wants $100 for its business, but the buyer is only willing to pay $75 at closing. However, the buyer is willing to pay an additional $25 after closing if certain post-closing milestones are met.

How are earnout payments treated in accounting?

Accounting treatment of the earnout. From an auditors perspective, payments associated with a specific post-deal period of employment of the seller will be treated as compensation. On the other hand, if payments are made regardless of the sellers employment, it could be recognized as additional purchase price.

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Blackout Earn Out Agreement