How do buyer and seller bridge the “Price Gap” between seller’s expectations and buyer’s fears?
Earn-out agreements have long been introduced into merger/acquisition transactions when Buyers and Sellers have a “price gap” impasse; yet both have the common goal of arriving at an agreement that meets the needs of both Parties. Earn-outs may also provide a flexible way to deal with Buyer/Seller differences, future uncertainties and post-acquisition potential. Most successful earn-out agreements are simple, well defined and short term. There are a number of fundamental issues that frame the negotiations of an earn-out package:
- Type of Agreement: the earn-out may be part of the purchase, license, royalty, commission or employment agreements; tax considerations may be significant.
- Definition of Success: the metric that needs to achieved for the earn-out to be earned should be clear and understandable.
- Length of the Agreement: the start and ending dates the Seller is eligible to achieve the performance target.
- Earn-Out Formula: sets forth the conditions and amount of earn-out for any given period of time.
- Payment: directs how the earn-out is distributed: monthly, quarterly, annually or at the end of the contract.
There are many other issues that will need to be addressed by the legal teams. It behooves the Buyer and Seller to negotiate a structure that aligns the Buyer’s business objectives with the incentives provided to the Seller.