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How to Highlight Earn Out Agreement

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Mergers and acquisitions often report fixed prices, like "Company A is acquiring Company B for ten million dollars." However, this price can be contingent. An earn-out is a specific type of contingent payout that allows sellers, typically shareholders of the target company, to receive additional payments if the company meets certain financial goals within a specified period. For example, a buyer might agree to pay 10 million dollars upfront and, if Company B achieves a net income of at least 2 million dollars in the following year, an additional 500,000 dollars would be paid. Thus, the total could reach 10 million plus any potential earn-out.

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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.

What are the different types of earnout structures?

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

What is a typical earn out percentage?

The typical term of an earnout is one to three years at approximately 10% to 25% of the purchase price. Earnouts are popular with private equity groups that do not always have the expertise to run a business and want to keep the owner incentivized following the closing.

What is an example of an earnout clause?

If an entrepreneur seeking to sell a business is asking for a price more than a buyer is willing to pay, an earnout provision can be utilized. In a simplified example, there could be a purchase price of $1 million plus 5% of gross sales over the next three years.

What is a typical earn out period?

A typical earnout takes place over a three to five-year period after closing of the acquisition and may involve anywhere from ten to fifty percent of the purchase price being deferred over that period.

How is fair value calculated for Earnouts?

Simply stated, earnout value is equal to the probability of success, or of each possible outcome, multiplied by the amount to be paid given the outcome. Usually, the company assesses the probabilities and then applies a discount based on the time value of money and the probability that the company is unable to pay.

What are the types of earnout arrangement?

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

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

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