Get more from the sale of your business: the earn-out


Get more from the sale of your business: the earn-out

Thomas Vandersmissen

Every sale of a business creates tension between vendor and buyer regarding the most essential aspects, particularly the price and the way in which this is set. The visions of the vendor and buyer often vary substantially. The vendor knows his business and the opportunities it presents and will often include future profitability when calculating a price. This is not so for the buyer. He can only work on the basis of the available figures from the past. He knows the approximate value of the business now. But can't be sure about the future.

The gap between vendor and buyer regarding expectations for the future often results in disagreement about the price. This should not, however, get in the way of a deal. Legally speaking, the gap can be easily bridged by making part of the price variable and linking it to future business profitability. Part of the price can subsequently be linked to the parties' expectations. If the expectations prove to be realistic, the buyer will not be overly concerned about paying a higher price. He will also be enjoying the (increased) profits at that point.

The principle of the variable price on the basis of set parameters is referred to as the 'earn-out' when talking about takeovers. Parties have enormous freedom to agree which parameters are relevant and which element of the price is included. There are also a few important focus areas. Earn-out provisions are often somewhat ambiguous and can result in long legal cases. A summary:

1) The parameters that are linked to the price must be crystal clear. The simpler they are, the less room there will be for interpretation. Complex formulas and corrections must be avoided.

2) The parameters for setting the price must be objective. A concept such as 'profit' for example is not recommended as the buyer can easily impact upon this. Use parameters where little influence can be exercised by either party.

3) As vendor, you must be able to check whether the parameters have been fulfilled. This implies that you must have access to specific information. A management mandate is also sometimes recommended for the vendor.

4) Set up a procedure to cover a situation where the parties disagree on the fulfilment of the parameters or the calculation of the price. The appointment of an expert to provide binding advice can help prevent long, drawn-out legal cases.

If these focus areas are taken into account, parties can set the earn-out according to their own insights. Once the principles have been agreed, you are still advised to have them checked by a third party. If this third party clearly understands how the price will be calculated, the vendor and buyer have done a good job.

Because the earn-out is so important within the contract, you are advised to engage a lawyer who has particular expertise in this type of matter. He can draft this clause (and potentially the whole takeover contract) carefully, according to your requirements.