Earn-out agreement – opportunities and risks from the seller’s point of view
To bridge different ideas about the amount of the purchase price between buyer and seller, for example due to information asymmetries between the parties and / or an uneven risk tolerance of the involved parties earn-out clauses are very common. In most cases, an earn-out agreement consists of two monetary components, the fixed base purchase price and a variable additional purchase price, with a payment period of often three to five years. In the course of the purchase contract negotiations, it could be agreed, for example, that 70% of the purchase price will be paid immediately and the remaining 30%, which are to be regarded as a variable component, occur in subsequent years. In addition, the variable component is linked to the achievement of contractual, financial and non-financial conditions. Thus, these earn-out clauses could generally be of created as an option. The predefined goals are, for example, forecast sales and / or earnings ratios.
An earn-out clause increases the likelihood of a transaction unless a buyer is prepared to pay the seller’s intended purchase price. In addition, the seller sets with the acceptance of an earn-out positive signals for a credible and sustainable business plan. However, such an agreement also causes problems for the seller. The previously agreed goals and the measurement of their achievement leads in the implementation increasingly to divergent views between buyer and seller. The reason is that the buyer can theoretically shape the degree of goal achievement in his favor. It depends on whether the seller is still active in the company or completely eliminated after the sale. In the first case, of course, he has the opportunity to continue to influence the achievement of objectives, which in turn restricts the buyer in his freedom of choice. In the second case, the seller no longer has any active influence on the achievement of the goals, which may lead to differences between buyer and seller. Thus, the buyer dominates the earn-out period and it can lead to manipulation. Before agreeing to an earn-out agreement, the seller should consider whether the strike price is also satisfactory, as this may possibly be the only amount paid without a debate.