Earn-out in M&A

Earn-out in M&A

Does #earnoutย inย #mergersandacquisitionsย work?

In M&A deals, especially in private transactions, ๐—ฒ๐—ฎ๐—ฟ๐—ป-๐—ผ๐˜‚๐˜ ๐—ถ๐˜€ ๐—ฎ๐—ป ๐—ฒ๐˜€๐˜€๐—ฒ๐—ป๐˜๐—ถ๐—ฎ๐—น ๐—ฝ๐—ผ๐˜€๐˜-๐—ฐ๐—น๐—ผ๐˜€๐—ถ๐—ป๐—ด ๐—ฎ๐—ฑ๐—ท๐˜‚๐˜€๐˜๐—บ๐—ฒ๐—ป๐˜ on the purchase price to bridgeย #valuationย differences between the buyer and the seller. As a result, the ๐—ฒ๐—ฎ๐—ฟ๐—ป-๐—ผ๐˜‚๐˜ ๐—ฝ๐—ฒ๐—ฟ๐—ถ๐—ผ๐—ฑ ๐—ฎ๐—ป๐—ฑ ๐—บ๐—ถ๐—น๐—ฒ๐˜€๐˜๐—ผ๐—ป๐—ฒ ๐—ฝ๐—ฎ๐˜†๐—บ๐—ฒ๐—ป๐˜๐˜€ ๐—ฏ๐—ฒ๐—ฐ๐—ผ๐—บ๐—ฒ ๐—ฎ ๐—ป๐—ฒ๐—ด๐—ผ๐˜๐—ถ๐—ฎ๐˜๐—ถ๐—ผ๐—ป ๐˜€๐˜‚๐—ฏ๐—ท๐—ฒ๐—ฐ๐˜ between the parties. The buyer thinks it is hedging its risk and thus willing to overpay for the deal because if the target does not perform, it will not get earn-outs.

In my experience, earnout metrics focus on EBITDA, though, in a few deals, i have observed buyers use revenues as a metric.

However, ๐—ฒ๐—ฎ๐—ฟ๐—ป-๐—ผ๐˜‚๐˜ ๐—ฑ๐—ผ๐—ฒ๐˜€ ๐—ป๐—ผ๐˜ ๐˜„๐—ผ๐—ฟ๐—ธ, if there are synergies in the deal and the buyer has paid a premium to realise synergies. In addition, after the deal closes, the ๐—ฏ๐˜‚๐˜†๐—ฒ๐—ฟ ๐—ฎ๐˜€๐˜€๐˜‚๐—บ๐—ฒ๐˜€ ๐˜๐—ต๐—ฒ ๐—ฒ๐—พ๐˜‚๐—ถ๐˜๐˜† ๐—ฐ๐—ผ๐—ป๐˜๐—ฟ๐—ผ๐—น ๐—ผ๐—ณ ๐˜๐—ต๐—ฒ ๐˜๐—ฎ๐—ฟ๐—ด๐—ฒ๐˜. In contrast, the seller wants to take control of the daily operations until the earnout period. Suppose the buyer keeps the seller independent until the earnout period. In that case, it delays any synergies realisation (cost cutting, market access for revenues synergies) for which it had paid a deal premium.

This ๐—ฐ๐—ผ๐—ป๐—ณ๐—น๐—ถ๐—ฐ๐˜ ๐—ถ๐—ป ๐˜๐—ต๐—ฒ ๐—ถ๐—ป๐˜๐—ฒ๐—ฟ๐—ฒ๐˜€๐˜๐˜€ ๐—ฏ๐—ฒ๐˜๐˜„๐—ฒ๐—ฒ๐—ป ๐˜๐—ต๐—ฒ ๐—ฏ๐˜‚๐˜†๐—ฒ๐—ฟ ๐—ฎ๐—ป๐—ฑ ๐˜€๐—ฒ๐—น๐—น๐—ฒ๐—ฟ ๐—ฑ๐—ฒ๐˜€๐˜๐—ฟ๐—ผ๐˜†๐˜€ ๐˜๐—ต๐—ฒ ๐—ฑ๐—ฒ๐—ฎ๐—น’๐˜€ ๐˜ƒ๐—ฎ๐—น๐˜‚๐—ฒ. Thus, rather than allocating earnout as a component for the purchase price, the ๐—ฏ๐˜‚๐˜†๐—ฒ๐—ฟ ๐˜€๐—ต๐—ผ๐˜‚๐—น๐—ฑ ๐—ฝ๐—ฒ๐—ฟ๐—ณ๐—ผ๐—ฟ๐—บ ๐—ฎ๐—ฑ๐—ฒ๐—พ๐˜‚๐—ฎ๐˜๐—ฒ ๐—ฑ๐˜‚๐—ฒ ๐—ฑ๐—ถ๐—น๐—ถ๐—ด๐—ฒ๐—ป๐—ฐ๐—ฒ to understand the target’s business to ๐—ฟ๐—ฒ๐˜€๐˜๐—ฟ๐—ถ๐—ฐ๐˜ ๐—ฒ๐—ฎ๐—ฟ๐—ป-๐—ผ๐˜‚๐˜ ๐—ฝ๐—ฎ๐˜†๐—บ๐—ฒ๐—ป๐˜๐˜€/ ๐—ฝ๐—ฒ๐—ฟ๐—ถ๐—ผ๐—ฑ ๐˜๐—ผ ๐—ฎ ๐—บ๐—ถ๐—ป๐—ถ๐—บ๐˜‚๐—บ ๐—ฝ๐—ฒ๐—ฟ๐—ถ๐—ผ๐—ฑ (not more than 12 months).

In this way, the ๐—ฏ๐˜‚๐˜†๐—ฒ๐—ฟ ๐—ฑ๐—ผ๐—ฒ๐˜€ ๐—ป๐—ผ๐˜ ๐—ผ๐˜ƒ๐—ฒ๐—ฟ๐—ฝ๐—ฎ๐˜†, and this transition period is enough for the buyer to assume control of the target business and executeย #synergies.



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