May 19 2014
So you’ve been negotiating the sale of your business and while you’re confident that it’s going to continue to grow as you’re projecting, the buyer just isn’t sure and you’re too far apart on price to reach agreement. To break the impasse, the buyer suggests an earnout where part of the purchase price is hinged on the future performance of the business and is payable if certain financial or operational targets are met.
As a seller, under an earnout you’re effectively trading the certainty of less money up front for the chance of more money over time. Before you agree to an earnout there are five critical things you need to do:
- Get the highest possible cash price up-front.
- Figure out the buyer’s motivations for buying the business and what they’re likely to do with it post-settlement.
- Use an objective measure, such as sales, as the target rather than something like net profit. The latter is more subject to manipulation.
- Think carefully about the key determinants of whether the target will be met and what could push the business in an unintended direction, and what you can do to influence those things.
- Get experienced accounting, tax and legal input.