Turning to Earn-outs

A potential solution for negotiation stalemates

Sometimes merger and acquisition negotiations reach an impasse - even when both parties are committed to making the deal succeed. When buyers and sellers are at loggerheads over pricing, all of the transaction's benefits can fall to the wayside.

There may, however, be an alternative: an earn-out. With an earn-out agreement, the buyer agrees to make periodic payments to the seller if the company meets specific performance goals. In some cases the seller may choose to stay with the company to be able to influence its results after it has been sold.

INCENTIVES FOR EVERYONE

An earn-out can be a particularly effective way to bridge the gap when the buyer and seller disagree about the value of the company. The promise of future payments can assuage seller concerns that they're settling for a price that undervalues their business. And, assuming the seller continues to work in the business, earn-outs help reassure the buyer that the seller will work hard to maintain the company's performance. In many cases earn-outs are more effective, and easier to measure, when the selling company continues to operate as a stand-alone subsidiary or the seller continues to manage it as a division of the acquiring company. If a target is intended to be immediately absorbed by the buyer, earn-outs may not make sense unless they are tied to top line revenue because sellers will have little or no control over the newly merged company's profitability.  [Click to read entire article]