An earnout, or contingent consideration, is a type of pricing structure for mergers and acquisitions (M&A), in which the buyer makes additional payments to the seller as the business in question reaches certain milestones. You might consider this pricing structure if you and the other party disagree on the value of the purchased company.
To learn more about earnouts in mergers and acquisitions in Georgia, speak with a legal professional at Sparks Law. Our knowledgeable mergers and acquisitions lawyers can advise you on navigating the sale or purchase of a business.
Whether or not you decide to do an earnout is dependent on many factors, including the size and type of the company being merged or acquired. Contingency considerations are commonly used for the sale of companies that rely heavily on customer relationships for their income. Common types of businesses that you might consider purchasing with an earnout include:
If you are unsure how to structure the purchase or sale of a company, a business attorney can help you make an informed decision.
Contingent considerations usually have complex compensation structures tied to them. The buyer may include various requirements regarding the retention of customers and preserving the business’s profitability.
For example, someone selling a law firm would probably be able to maintain 80 or 90 percent of their clients if they set up a competing business. In this case, the buyer would only be willing to pay for the 10 or 20 percent of clients that would stay with the current firm.
When negotiating the sale, the buyer would most likely put the original owner on an earnout, in which the seller works on a commission basis for a certain period of time. This could last from a few months to a few years. After the contingency period, the seller should be convinced that the original owner has transferred all their specialized knowledge and retained as many customer relationships as possible.
Earnouts are beneficial because they offset the purchaser’s risk and incentivize the seller to ensure the business remains profitable. However, navigating the relationship between the seller and the new owner can be challenging.
If you just sold your company, the new owner might have a different management style than you. They may want to terminate long-term employees, break off ties with certain vendors, and bring in their own team. Complicated rivalries between old and new team members can hurt the business.
These disagreements can become significant problems if the new owner’s decisions cause the company’s profits to drop. When the profits decreases, the earnout decreases as well. Consequently, the seller makes less money on the sale. This is known as a perverse incentive.
It is incredibly difficult to write an earnout contract for a merger or acquisition that offsets risks for both parties and guarantees a smooth transition of power. So, it is best to hire an attorney with experience handling these types of legal agreements.
If you’re selling a company, you should consider hiring a lawyer to draft a term employment contract to protect your rights. This legal agreement requires the buyer to pay you a salary throughout the entire earnout period of the merger or acquisition. Having guaranteed income after the initial sale protects you from risk. However, it can leave the buyer vulnerable if the company begins to lose money.
Regardless of whether you’re buying or selling a company, you should get the compensation you are owed. Earnout agreements can protect both buyers and sellers if they are drafted properly. Whatever your role is in the sale, a skilled attorney can write provisions that offset as much risk as possible. Contact us today to discuss earnouts in mergers and acquisitions in Georgia.