We place special emphasis on the variety of options for deal structure in our M&A conferences, given their importance in the ultimate outcome of the transaction. Negotiating a favorable price is often much easier than getting the best structure, and balancing risk with opportunity and tax efficiency can be challenging. Earnouts represent one such aspect of deal structure, one that has no lack of horror stories from when it goes wrong.
Earnouts are a way to structure an M&A transaction to defer part of the deal value, subject to the future performance of the business. These are often used to bridge the gap in value expectations between buyer and seller. We typically advise against earnouts. They can unduly complicate the deal, and shift significant risk to the seller. Barring other options, though, we seek to keep the terms as unambiguous as possible, and structured so the control of achieving targets remains in the hands of those who will receive the earnout rewards.
In such cases, it’s typically better to have the outcome based simply on revenue growth rather than EBITDA, which may be harder to control. If not carefully structured, the incentives may be diminished, and the performance objectives originally envisioned by both buyer and seller never achieved.
Now, having given you all the cautions, properly structured, I was able to get a client an additional $50 million that would never have been feasible otherwise… so horror stories aren’t all that can come from earnout!