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Aug 6th, 2022
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How to Clean picture in the Earn Out Agreement

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[Music] hey guys welcome to another edition of inside the exit I'm your host drew Brantley joined today by Bob fresh welcome to the show thanks q guys today we're talking about earn outs and seller notes so when you're selling a company you know most sellers you want to get the most for your company that you can or you have a number in mind or you want to push people to try to give you more money at the end of the day sometimes when you're selling a company there's a there's a gap between what you believe is the right number for the company and what a buyer is willing to sell and oftentimes earn outs and seller notes are financial tools that are able to kind of bridge that gap in valuation it's basically a way for you to get more money for your company but you don't get it at the close you know when the wires when the wires flow sometimes it means these amounts are going to get paid out over multiple years or a five-year period or two years or whatever it is so let's talk a little bit...

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An earnout is a business purchase arrangement in which the seller finances the business and the seller's payment is based on the business's future performance. An earnout allows the buyer to have more time to pay for the business.
Earnout is often used to bridge “purchase price gaps” between a buyer and seller. For example, a seller wants $120 million for its business, but the buyer only wants to pay $100 million at closing. However, the buyer is willing to pay an additional $20 million after closing if certain post-closing milestones are met.
The differing expectations of a business between a seller and a buyer are usually resolved through an earnout. The earnout eliminates uncertainty for the buyer, as they only pay a portion of the sale price upfront and the remainder based on future performance. The seller receives the benefits of future growth.
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 ...
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.
To the extent that 100% or greater of the EBITDA Target is met during any Earnout Period, the Company Stockholders shall receive the entire Earnout Payment for such period.
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 Earnout? 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.
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 ...
In most circumstances, Generally Accepted Accounting Principles (“GAAP”) require contingent consideration, such as an earnout, to be recorded as a liability on the opening balance sheet of the buyer.

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