EARN-OUTS: A Useful Tool In M&A Transactions for Bridging Gaps In Perceptions of Business Value


Earn-outs are a useful tool in M&A transactions to bridge disagreements between buyers and sellers about a company’s valuation. Where such disagreement exists, an earn-out provides “deal insurance” for both the optimistic seller and the cautious buyer by agreeing that a portion of the deal consideration will be contingent upon the performance of the company after the deal has closed. In a down economy, disagreements about the valuation of businesses will likely increase as buyers’ bargaining power relative to sellers’ bargaining power increases, buyer caution abounds, and access to capital is limited. Sellers can potentially use an earn-out to get closer to what they believe the business would be worth in a better economic climate.

The following article provides a summary of earn-outs, certain advantages and disadvantages of including an earn-out mechanism in deals, and some important considerations in choosing how to structure earn-outs.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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