Replace Value Choice into the Earn Out Agreement

Aug 6th, 2022
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How to Replace Value Choice into the Earn Out Agreement

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when you hear about mergers and acquisitions in the news you typically hear something like company a is acquiring Company B for ten million dollars and that makes it seem like this ten million dollars is a fixed price sometimes it is but sometimes its not you could have a contingent payout thats part of the deal and that is what in earn-out is and are not satai p-- of contingent payout specifically its an agreement thats gonna allow the seller okay so the shareholders who own stock and Company B lets say Company B is the target here theyre gonna be entitled to receive additional money if the target company were to hit certain financial goals in the next few years so for example if you are acquiring company Bs so you know what Ill pay 10 million dollars upfront but if in the next year your companys a company Bs net income is at least two million dollars then Ill kick in an additional five hundred thousand so then youd be paying 10 million plus potentially an additional five

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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.
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.
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.
Alternatives to an earnout should be consideredsuch as performance-related employee compensation or bonuses (subject to tax and other considerations); contingent value rights (CVRs); or, where the achievement of specific non-financial milestones are critical, milestone payments tied to those achievements.
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.
Earn-outs do not affect the Sources Uses schedule for the initial transaction since no cash is paid out yet. Earn-outs *increase* the amount of Goodwill created in an MA deal because they boost the Liabilities side of the Balance Sheet, which, in turn, requires higher Goodwill on the Assets side to balance it.
An earnout mechanism is a purchase price adjustment in the company acquisition contract, under which part of the purchase price due to the vendor will be paid in the future.
An earn-out (whether tied to a specific event or some performance metric) can also bridge a valuation gap where buyer and seller disagree on the enterprise value of the business as of the closing. An easily-achievable earn-out can also provide payment flexibility by functioning much like true seller financing.

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