An earnout pricing structure is typically used in mergers and acquisitions when the buyer needs the seller to continue working at the company to ensure customer retention and maintain profitability. A portion of the purchase price is based on the company’s profits during the earnout period, which incentivizes the seller to keep the business running smoothly throughout the transfer of power.
Like any other contract, you should always know exactly what you are agreeing to under the terms of the agreement. If you’re in the process of selling your company, talk to one of our lawyers about sellers’ responsibilities in Georgia earnouts.
An earnout is typically calculated as a percentage of the total purchase price of the company being acquired or merged. This percentage is based on the estimated number of customers that would stay with the company if the original owner completely removed themselves from the business. For example, if you’re the buyer and believe only 70 percent of the customer would remain if the current owner left, you might hold back 30 percent of the purchase price.
You would pay the remaining 30 percent to the seller on the condition that they remain with the company and maintain customer and vendor relationships for the entire earnout period (typically three to 24 months). As a seller, you must know how earnout pricing works, so you understand how much money you could lose by failing to fulfill your contractual obligations.
The seller’s responsibilities during an earnout depend on how the purchase agreement is written. Your specific contract might state that you stay at the company working five hours a week for six months. Some agreements may include provisions stating the seller must work 40 to 50 hours a week at the company for the next year. Most of the provisions in an earnout contract are based on the original owner’s ability to maintain relationships with vendors, employees, and customers.
When negotiating an earnout contract, there is a lot of negotiation between the parties about what constitutes cause to fire the seller and avoid paying the remainder of the purchase price. As the buyer, you want the ability to fire the seller “for cause,” meaning you can fire them for reasons listed in the agreement. Common examples of grounds to terminate the seller in an earnout include:
So, if your seller was initially supposed to make $200,000 in the first year of the earnout, but they breached the terms of the contract in the third month, you would not have to pay them the remainder of the money.
As a seller, you must be aware of the potential loopholes in your earnout contract. There may be a term stating you can be terminated at the sole discretion of the buyer. If you sign an agreement like that, you can be fired for any reason at any time, losing the money you expected to make in the earnout. Regardless of your role in the earnout, our skilled Georgia attorneys can ensure your contract clearly dictates the seller’s responsibilities.
If you signed an earnout contract with the person buying your company, you must understand the exact nature of your responsibilities and what can cause you to be terminated. As the buyer, you should clearly state the seller’s duties to ensure the business remains profitable. Contact Sparks Law today to learn more about sellers’ responsibilities in Georgia earnouts.
