BROWSE

Earnout

Definition

Earnout refers to a pricing structure in mergers and acquisitions where the sellers must "earn" part of the purchase price based on the performance of the business following the acquisition.

What is 'Earnout'

An earnout is a contractual provision stating that the seller of a business is to obtain additional compensation in the future if the business achieves certain financial goals, which are usually stated as a percentage of gross sales or earnings. If an entrepreneur seeking to sell a business is asking for a price more than a buyer is willing to pay, an earnout provision can be utilized. In a simplified example, there could be a purchase price of $1,000,000 plus 5% of gross sales over the next three years.

Explaining 'Earnout'

There are no hard and fast rules, with the payout's level dependent on a number of factors, including the size of the business. This can be used to bridge the gap between differing expectations from the buyers and sellers. The earnout helps eliminate uncertainty for the buyer as it is tied to future financial performance. The seller also receives the benefits of future growth for a period of time.

Key Issues

There are a number of key considerations, aside from the cash compensation. This includes determining the crucial members of the organization and whether an earnout is extended to them. The length of the contract and the executive's role with the company post-acquisition are two issues that also have to be negotiated.

A Hypothetical Example

ABC Company has $500 million in sales and $50 million in earnings. A potential buyer is willing to pay $250 million, but the current owner believes this undervalues the future growth prospects and asks for $500 million. To bridge the gap, the two parties can use an earnout. A compromise might be to an upfront cash payment of $250 million and an earnout of $250 million if sales and earnings reach $1 billion within a three-year window or $100 million if sales only reach $600 million.


Further Reading


Earnouts: A study of financial contracting in acquisition agreements
www.sciencedirect.com [PDF]
We empirically examine earnout contracts, which provide for contingent payments in acquisition agreements. Our analysis reveals considerable heterogeneity in the potential size of the earnout, the performance measure on which the contingent payment is based, the …

Contingent earnouts in acquisitions of privately held targetsContingent earnouts in acquisitions of privately held targets
journals.sagepub.com [PDF]
We empirically examine earnout contracts, which provide for contingent payments in acquisition agreements. Our analysis reveals considerable heterogeneity in the potential size of the earnout, the performance measure on which the contingent payment is based, the …

Earnouts: The effects of adverse selection and agency costs on acquisition techniquesEarnouts: The effects of adverse selection and agency costs on acquisition techniques
academic.oup.com [PDF]
We empirically examine earnout contracts, which provide for contingent payments in acquisition agreements. Our analysis reveals considerable heterogeneity in the potential size of the earnout, the performance measure on which the contingent payment is based, the …

The role of earnout financing on the valuation effects of global diversificationThe role of earnout financing on the valuation effects of global diversification
link.springer.com [PDF]
We empirically examine earnout contracts, which provide for contingent payments in acquisition agreements. Our analysis reveals considerable heterogeneity in the potential size of the earnout, the performance measure on which the contingent payment is based, the …

Technological-induced information asymmetry, M&As and earnouts: stock market evidence from GermanyTechnological-induced information asymmetry, M&As and earnouts: stock market evidence from Germany
www.tandfonline.com [PDF]
We empirically examine earnout contracts, which provide for contingent payments in acquisition agreements. Our analysis reveals considerable heterogeneity in the potential size of the earnout, the performance measure on which the contingent payment is based, the …

Earnouts in mergers and acquisitions: A game-theoretic option pricing approachEarnouts in mergers and acquisitions: A game-theoretic option pricing approach
www.sciencedirect.com [PDF]
We empirically examine earnout contracts, which provide for contingent payments in acquisition agreements. Our analysis reveals considerable heterogeneity in the potential size of the earnout, the performance measure on which the contingent payment is based, the …

Discussion: Financing acquisitions with earnoutsDiscussion: Financing acquisitions with earnouts
www.sciencedirect.com [PDF]
We empirically examine earnout contracts, which provide for contingent payments in acquisition agreements. Our analysis reveals considerable heterogeneity in the potential size of the earnout, the performance measure on which the contingent payment is based, the …

Earnouts in mergers: Agreeing to disagree and agreeing to stayEarnouts in mergers: Agreeing to disagree and agreeing to stay
www.jstor.org [PDF]
We empirically examine earnout contracts, which provide for contingent payments in acquisition agreements. Our analysis reveals considerable heterogeneity in the potential size of the earnout, the performance measure on which the contingent payment is based, the …

Religion and mergers and acquisitions contracting: The case of earnout agreementsReligion and mergers and acquisitions contracting: The case of earnout agreements
www.sciencedirect.com [PDF]
We empirically examine earnout contracts, which provide for contingent payments in acquisition agreements. Our analysis reveals considerable heterogeneity in the potential size of the earnout, the performance measure on which the contingent payment is based, the …

Financing acquisitions with earnoutsFinancing acquisitions with earnouts
www.sciencedirect.com [PDF]
We empirically examine earnout contracts, which provide for contingent payments in acquisition agreements. Our analysis reveals considerable heterogeneity in the potential size of the earnout, the performance measure on which the contingent payment is based, the …



Q&A About Earnout


Who should receive an earnout?

The crucial members of the organization should receive an earnout.

What are some key considerations when using an earnout?

The length of the contract and executive's role with the company post-acquisition are two issues that also have to be negotiated.

What is an earnout?

An earnout is a contractual provision stating that the seller of a business will obtain additional compensation in the future if the business achieves certain financial goals.

How long should you negotiate for in your earnout agreement?

You should negotiate for at least three years, but no longer than five years.