Article Summary: Should You Take an Earnout? | Axial

By Meghan Daniels, Axial | November 1, 2016

I have pared down the article to the key points.  If you would like to read the entire article, click on the link at the bottom of the summary - Eric Gall

• Earnouts are a way to bridge the gap between a seller’s expectation of value and a buyer’s willingness to pay. 
• Earnout structure varies, but the idea is buyers make additional payments post-close, dependent on the business achieving certain goals.
• When properly structured, earnouts can work very well. 
• Earnouts can also turn nightmarish in the event of misaligned expectations, unfriendly terms, and hidden stipulations.

Photo by Robert Caplin

When Earnouts Go Wrong

Careful legal wording can protect against bad behavior. Examples are buyers making major changes that tank the company and rollups where buyers credited the wrong business with sales to avoid the earnout.

Earnouts can create misalignment of interests between management and shareholders leading to maximizing the earnout vs. maximizing shareholder value.

Clawbacks and Earnout Alternatives

Management incentive agreements preferred over earnouts.  Agreements should include assurances if the company is acquired the owner won’t be terminated or will receive a severance.

Clawbacks allow the seller to accept a lower valuation but if the company grows to a certain level, they ‘claw back’ equity.  Clawbacks align buyer and seller on a longer term basis than an earnout.

Advice for Sellers

Earnouts require protective provisions and need to be realistic.

1. Make sure you have a cumulative clause for multiple year earnouts. 
2. Be wary of buyers factoring in basic risk of the industry into the earnout. 
3. Base the earnout on revenues, not EBITDA. 

Article LINK

For additional information regarding Florida business sales, acquisitions and valuations, please contact Eric J. Gall at Eric@EdisonAvenue.com or 239.738.6227. Also, visit our Edison Avenue website at www.EdisonAvenue.com.