Buyers and Sellers Can Bridge Gap With Earnouts, But Must Know Accounting Rules
By Sean R. Saari, Partner, Advisory Services
I’m pretty sure my first experience with earnouts came at the lunch table with my buddies in grade school.
“I bet you I can throw my sandwich wrapper into the trash can from here.”
“Yeah. I’ll bet you a dollar.”
While transaction earnouts involve many more dollars than my story, as well as much more complex terms, the concept is generally the same — an earnout is a payment based on performance. For example, a deal may include a $20 million cash payment and an earnout that calls for an additional $5 million to be paid over the next two years if certain EBITDA (earnings before interest, taxes, depreciation and amortization) targets are met.
Earnouts are often used in transactions to bridge the gap between what a buyer is willing to pay upfront and what a seller wants in the way of total compensation to complete a deal. Therefore, earnouts are typically constructed to allow the seller to enjoy additional upside if the acquired company reaches certain performance targets after the sale, while providing the buyer with downside protection in the event that the projected performance after the deal closes does not materialize.
Click here to read more about how buyers and sellers can bridge the gap with earnouts in Sean Saari’s most recent Crain’s Cleveland Dealmaker blog.