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Accepting an Earnout in an Acquisition?

Accepting an Earnout in an Acquisition?

Should you be comfortable accepting an earnout in an acquisition?

The short answer is…

Yes, if you can have an adequate level of trust in the other person to make good on payments.

If it’s a large corporation it goes without saying, it is a no-brainer. A large corporation is not going to default on their payments or get caught up in a scandal, unless they can dwarf you with their legal team after something failed/was illegitimate, and/or if they became insolvent during the length of the term.

This is mainly focused around small businesses or individuals who offer you an earnout.

Let’s say someone offers 50% upfront and 50% over time on a $5 million deal.

If it were me and I want to be protected, I would look at it at the frame of, this lens.

1) Most importantly. Is the upfront payment enough for me to feel secure about the deal? If I’m getting $2.5m, is that enough for me to say if I don’t collect another dime and I part with these assets, am I comfortable with the deal? If I plan on making $2m annually from the assets, is that $2m passive or active – and how secure is the money long term in comparison to the offer – because that factors heavily into whether I accept $2.5m plus an earnout or not.

2) Incentivize the buyer to pay you out by needing you. Stay tied together to the success of the business. Obviously, any good deal for the buyer will include a transition period where the seller stays on and helps the new owner get acquainted with the business and learn the ropes a bit. You want them to succeed with your assets. An adequate transition period would be 60 days to 90 days. So let’s say, the first 3 months you are heavily involved – so that’s 3 payments they realistically are definitely going to make to keep you in the transition period.

3) Let’s say that the earnout is 12 months, so we are looking at 9 months of trust on the other $1.875m and what can I do to cover that and is it worth me risking the deal to do it? How can you protect yourself with legal protection? We will explore this in depth.

If I was hesitant about the buyer, you could ask for a promissory note with a personal guaranty or collateral.

You would be protected by this clause here.

To the extent of any conflict between the terms and conditions of this Bill of Sale and the terms and conditions of the Agreement, the terms and conditions of the Agreement shall govern, supersede and prevail.

Just say you won’t press for a full promissory note.

But you can ask for a clause that suggests if you have to collect for breach he covers attorney fees.

But they could write in there wanting the same if there was a breach on your side. And then it’s about who has a better relationship with an attorney to take on a case that might be something an attorney normally wouldn’t trust but sees $ signs on the collecting attorney fees clause where they just run up a big bill on purpose.

The real thing is if you get the sense the buyer has deep enough pockets and you trust him to pay you will be good. All signs should point to that they can and will and they trust you and the business.

Make sure you deliver all those assets and you overwhelm him with the transition period.

Hesitancy about the buyer would mean something along the following:

  1. We were conducting a transaction in different states.
  2. I never met them in person.
  3. I didn’t see any physical assets they own.
  4. He didn’t have adequate cash (50% upfront) coming in

If any of the above were going on, I would most likely request a personal guaranty and collateral.

The basic is with any deal though:

Every request weakens the deal. 

Practically speaking, I would get any decent offer closed as it is without modification.
One thing to watch out for is the name on the agreement.

You want the Buyer to be a well funded company the Buyer cares about, or the individual themselves so the don’t shield the transaction behind some entity that has no assets and something they can close up.

Remember, to work with Jarbly Acquisitions to maximize your deal, assist you with negotiations, and help you secure the best terms for your sale.

We have thousands of buyers looking for businesses like yours, where we represent & protect the Seller in a transaction where we have your listing.

Email Us: acquisitions@Jarbly.com
Call Us: (800) 773-1523

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