All about the earn-out arrangement

There are many things to consider when selling a business. One of the most important and most difficult elements is often the selling price. Negotiations can get bogged down here, for example, because the buyer is not prepared to pay enough or is unable to obtain sufficient financing. One of the solutions that can be offered for this is the agreement of an earn-out arrangement. This is an arrangement whereby the buyer only pays part of the purchase price after one or more specific results have been achieved within a certain period of time after the transaction date. Such an arrangement also seems suitable to be agreed upon if the value of the company fluctuates and therefore a purchase price is difficult to establish. In addition, it can be a means of balancing the risk allocation of the transaction. However, whether it is wise to agree on an earn-out scheme strongly depends on the concrete circumstances of the case and on how this earn-out scheme is drawn up. In this article, we will tell you more about the earn-out arrangement and what you should pay attention to.

All about the earn-out arrangement

Conditions

In an earn-out scheme, the price is thus kept low at the time of the sale itself and if a number of conditions are met within a certain period of time (usually 2-5 years), the buyer must pay a remaining amount. These conditions can be financial or non-financial. Financial conditions involve setting a minimum financial result (known as milestones). Non-financial conditions include, for example, that the seller or a certain key employee will continue to work for the company for a certain period after the transfer. One can also think of concrete goals such as obtaining a certain market share or a licence. It is very important that the conditions are drawn up as precisely as possible (for example, concerning the accounting: the way in which the results are calculated). After all, this is often the subject of later discussion. Therefore, an earn-out agreement often also provides for other conditions in addition to the targets and the period, such as how the buyer should act within the period, dispute arrangements, control mechanisms, information obligations and how the earn-out should be paid.

Commitment

The advice is often to be careful when agreeing on an earn-out arrangement. The vision of the buyer and the seller can differ considerably. The buyer will often have a longer-term vision than the seller, because the latter wants to achieve a maximum earn-out at the end of the term. In addition, a difference of opinion may arise between the buyer and the seller if the latter continues to work in the company. Therefore, in an earn-out arrangement, the buyer generally has an obligation of effort to ensure that the seller will be paid this maximum earn-out. Because the extent of the best-efforts obligation depends on what has been agreed between the parties, it is important to make clear agreements about this. If the buyer fails in his efforts, it is possible for the seller to hold the buyer liable with the amount of damages that he is short of because the buyer did not exercise enough effort.

Advantages and disadvantages

As described above, an earn-out arrangement may contain some pitfalls. However, this does not mean that there is no benefit to both parties. For example, it is often easier for the buyer to secure financing under an earn-out arrangement due to the construction of a low purchase price with a subsequent payment. In addition, an earn-out price is often appropriate as it reflects the value of the business. Finally, it may be nice that the former owner is still involved in the business with his expertise, although this may also cause conflict. The biggest disadvantage of an earn-out arrangement is that disputes often arise afterwards about the interpretation. In addition, the buyer may also make choices that negatively affect the targets within the scope of his obligation of effort. This disadvantage underlines all the more the importance of a good contractual arrangement.

Because it is so important to arrange an earn-out properly, you can always contact Law & More with your questions. Our lawyers are specialised in the field of mergers and acquisitions and will be happy to assist you. We can assist you in the negotiations and will be happy to examine with you whether an earn-out arrangement is a good option for the sale of your company. If this is the case, we will be happy to assist you in legally shaping your wishes. Have you already ended up in a dispute concerning an earn-out arrangement? In that case we will be pleased to assist you with the mediation or assistance in any legal proceedings.

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