An earnout – a financial arrangement in M&A in which a portion of a company’s purchase price is deferred and contingent upon its future performance – is a popular deal structure, especially during times of heightened risk or economic uncertainty.
For buyers, earnouts enable them to pay a lower cost upfront and spread the ultimate purchase price over a period of time (often as much as three years post-deal). For sellers, meanwhile, earnouts can generate a steady stream of cash in the post-sale period, providing the performance conditions are met.
In 2020, while M&A declined precipitously as a result of COVID-19, the percentage of deals involving earnouts increased, as buyers and sellers sought to mitigate the risks of their transactions and to bridge valuation gaps that resulted from the crisis.
According to private equity firm Allen & Overy, 20 per cent of the M&A deals they were involved in during 2020 utilised an earnout structure, a sharp increase from just 9 per cent of the deals they conducted during 2019.
With valuations forecast to be one of the main sticking points to M&A activity this year, it is likely that earnouts will once again prove to be integral to many hoping to strike deals, both on the buy and sell side.
However, an earnout is by no means a simple solution to gaps in valuation or to structuring deals in more financially feasible terms. It is an approach that requires extensive negotiation and rigorous structuring in order to reach an arrangement that both sides can agree on.
Before an agreement on the earnout structure can be reached, there are numerous considerations that need to be addressed, ranging from the payment terms and earnout period to tax implications and issues relating to governance and control during the post-deal period.
Why an earnout?
What is the best way to structure an earnout?
The tax considerations of an earnout
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