Earn out periode – yes or no?
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What are your thoughts on an earn-out period of 2 years? Where the sellery is based on the profit we are realizing with the acquisition.
Hi Lena,
I think it’s a good way to incentivize people to collaborate and contribute to the growth of the company.
CristinaI think the premise is a good one, based on profits or tied to performance metrics of post-merger performance. However, I think timeframe would be dependent on the complexity of the business including complexity of the acquisition. Simple, smaller mergers may need less time from the seller.
Hi Lena,
This response really comes down to goals of the buyer and seller. Do the 2 years sufficiently keep the seller engaged in the success of the business and are there other factors such as ownership and leasing of the building? Are the 2 years sufficient to provide the seller with the right amount of smoothing of funds for tax mitigation? Is this considered a standby for a loan? If the SBA is involved for lending, an earn-out is generally restricted from a deal given subjectivity and potential for legal challenges.
If you’re the seller I’ll add that you should also consider negotiating a mid-point earn-out, in this case, 1 year. This way, if you hit the target the first year, you get 50% (or any other %) of the earn-out “in advance”. If you hit the second’s year target, you’ll receive 100%, but if you don’t, at least you have received 50% of it. This way the earn-out is not binary (yes or no / 100% or 0%).
My organization actively uses earnout models (usually with very little cash up front as an advance against the earnout) for smaller businesses where the seller is going to join and continue to work with us. It definitely incentivizes the seller(s) to be invested in the business. For larger organizations or businesses where the seller is exiting and wants to get their payout to go retire with, it isn’t as well received. So, my answer is ‘it depends’ and buyers always have to know their audience and structure deals that meet the needs of both parties.
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