Welcome back to Part III in our month long series on M&A Negotiations. So far we’ve covered Liquidation Preferences and Accelerated Vesting. This week we cover the art and science of Earnouts.
Earnouts, AKA “getting paid later”, are a variable component to an acquisition’s purchase price.
These arrangements help buyer and seller bridge the gap between each side’s perceived valuation, while putting guardrails in place to safeguard the buyer against certain risks. Earnouts essentially ask the seller to “prove” a component of their worth.
Said another way, the earnout is often funded in part by the performance of the seller’s business. So it kinda pays for itself. Plus, there’s less risk of overpaying for a business
While earn outs force the seller to take some risk on behalf of the buyer, and effectively use their now-acquired business to earn the full purchase price, hopefully they also get an opportunity to achieve some upside.
So with that 40,000 foot view, let’s “earn” our keep:
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