Page 14 - NBIZ Magazine December 2020

By Patrick Ungashick

he term “earn-out” usually are used to bridge valuation gaps be- up to an additional $5 million after
sends a shiver down the spine of tween the seller and buyer. In essence, closing if the company sustains the 25%
Tbusiness owners and for a good with an earn-out, the buyer is saying (or better) growth rate over the next
reason. Business owners seeking to sell to the seller, “We will pay you more for several years.
his/her business at exit overwhelmingly your company later if you go out and Earn-outs can be useful in bridging
prefer all-cash deals. Owners know that achieve [blank]…” value gaps, and some deals might
any portion of the purchase price held Here’s an example. The seller never be closed without incorporat-
back at closing is at risk—meaning one believes his/her company is worth $15 ing an earn-out into the agreement.
might never see those dollars. Despite million, in part because you trust the However, an earn-out often trades one
owners’ overwhelming preference, most company will continue to grow 25% problem (i.e. the buyer and seller do
deals are not 100% cash transactions, per year like it has the last few years. not agree on the price) for another set
but instead, include any number of The buyer is not convinced that the of problems:
mechanisms that pay additional dollars growth rate is sustainable and is only
to the seller after closing only upon willing to pay $10 million at closing. 0 A seller and his/her buyer have to
achieving certain results. One of the To bridge the gap, the buyer agrees agree on the specific performance
most common mechanisms is an earn- to an earn-out that may pay the seller or milestones needed to receive
out. Here’s why owners seek to avoid earn-out payments. For obvious
earn-outs, and how to avoid getting reasons, buyers prefer to tie earn-
burned by them if part of one’s deal. outs to the bottom-line. Sellers,
however, beware. After the seller
Selling One’s Company has sold the company (or a portion

First, a quick explanation of what of it), he/she remains in control of
an earn-out is. An earn-out is a pro- very few factors that determine the
vision defining how a selling owner bottom line. Sellers should seek to
may receive additional payments after tie the earn-out to top-line results,
closing, contingent upon specific as they are easiest to measure and
results such as stipulated financial hardest to manipulate.
performance or milestones. Earn-outs

14 NBIZ ■ December 2020