Earnout agreements frequently come into play in M&A deals to resolve discrepancies between buyers and sellers regarding a company’s value. These agreements usually promise sellers payment contingent on meeting specific performance goals after the deal is sealed. While earnouts can align buyer and seller interests, they also pose distinct challenges requiring careful management
Determining the metrics for earnout payments
One of the main hurdles in earnout agreements is defining the metrics for earnout payments. These metrics need to be clear, objective, and measurable, while also reflecting the seller’s capacity to affect the result. For instance, if the seller must meet a revenue target, they should have control over the sales process. Similarly, if the metric relates to profitability, the seller should manage expenses.
Considerations when determining metrics include:
Seller’s influence on the outcome.
Buyer’s influence on the outcome.
Clarity, objectivity, and measurability of the metric.
Potential impact of external factors on the metric.
Disagreements over financial statements
Disputes over financial statements are another frequent issue in earnout agreements. Buyers might claim the seller didn’t meet metrics, while sellers might argue buyers manipulated statements to avoid payments. To address this:
Choose a neutral third-party auditor or accountant to review financials.
Establish a clear method for calculating earnout payments.
Include a dispute resolution process in the agreement.
Integration challenges
Earnout agreements can bring integration hurdles, especially if the seller stays involved post-closing. Differing strategies or priorities might clash. To manage integration challenges:
Outline a clear post-closing integration plan.
Define the seller’s role and duties post-closing.
Set up communication protocols to prevent misunderstandings.
Cultural differences
Cultural disparities between buyer and seller can complicate earnout agreements. Differences in business approaches may spark conflicts over strategy and decision-making. To address this:
Conduct cultural due diligence before the deal.
Define the combined entity’s cultural values and norms.
Establish decision-making and conflict resolution protocols considering cultural disparities.
While earnout agreements can bridge valuation gaps, they come with unique challenges. By carefully addressing metrics, integration plans, and cultural differences, parties can navigate these hurdles for a successful agreement.
For more information or if you find yourself involved in a Merger or Acquisition dispute, contact Pranav Bhanot at WYN Legal (pbhanot@wyn.legal)
