The sale of a company in an M&A transaction often involves consideration to the selling shareholders that is deferred and contingent on subsequent events in the life of the company, such as the post-acquisition performance of the business (an “earnout”). Earnouts are typically used where a buyer and seller disagree on the value of the target company or its business as of the date of the transaction. Through the use of earnout payments, buyer and seller can defer this valuation decision to a later point in time, and link it to the performance of the business or the target company’s product sales. Such valuation difference can be especially prominent for early-stage companies, with unproven products or technologies, or other companies for which historical results may be unreliable indicators of future value.
A typical earnout provision in an M&A agreement could provide, for example that, if the target company’s EBITDA percentage for the measurement period is greater than a certain percentage (e.g., 15%) the selling shareholders will be entitled to receive an additional consideration for their stock. The additional consideration amount could be determined by multiplying, the target company’s revenues for the measurement period by a certain percentage (e.g., 0.025).
Originally published in the Global Tax Weekly on July 17, 2014.
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