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How to Manage Earn Out Agreement

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Mergers and acquisitions often report fixed prices, such as "Company A is acquiring Company B for ten million dollars," but this isn’t always the case. Some deals include contingent payouts, known as earn-outs. An earn-out is an agreement allowing sellers (shareholders of the target company, Company B) to receive additional payments if the target meets specific financial goals. For instance, if Company A agrees to pay ten million upfront but stipulates an additional payment of five hundred thousand if Company B achieves a net income of two million dollars within a year, the total payment could exceed ten million. Thus, earn-outs tie additional compensation to future performance metrics.

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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 a management earn-out?

Often, when buyers and sellers want to complete a deal but cant agree on the price, they employ a strategy called an earn-out. An earn-out is a contingent payment that the seller only receives from the buyer when specific performance targets are met.

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 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 are examples of earn outs?

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.

What is a typical earn-out?

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.

What is the purpose of an earnout?

An earnout is a contractual mechanism in a merger or acquisition agreement, which provides for contingent additional payments from a buyer of a company to the sellers shareholders. Earnouts are typically earned if the business acquired meets certain financial or other milestones after the acquisition is closed.

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.

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