What is a typical earn-out structure?

An earnout is a contractual arrangement between a buyer and seller in which a portion or all of the purchase price is paid out contingent upon the target firm achieving pre-defined financial thresholds and/or operating milestones post-transaction.

What is earn-out strategy?

Often, when buyers and sellers want to complete a deal but can’t agree on the price, they employ a strategy called an “earn-out.” An earn-out is a contingent payment that the seller only receives from the buyer when specific performance targets are met.

Are earn outs common?

Earnouts are rare in smaller transactions but common in mid-market deals. In some circumstances, as you’ll see below, an earnout can be tied to as much as 25% of the purchase price. To receive an earnout, the seller must meet or exceed specific targets or milestones.

How are earn outs calculated?

Earn-out Payments.

What this means in plain language is the following: The buyer will pay the seller an earn-out equal to the seller’s EBIT less some agreed-upon EBIT threshold times 1.5, if the subtraction results in a positive number.

How do I negotiate my Earnouts?

Tips for Negotiating an Earn-out
  1. Ask for a seat at the table when the goals are being set. Most earn-out agreements are drafted in isolation by the acquiring firm and presented to the seller as a ‘fait accompli. …
  2. Agree to goals that reward integration results. …
  3. Sprinkle goals throughout the earn-out period.

Is an earnout a contingent liability?

In most circumstances, Generally Accepted Accounting Principles (“GAAP”) require contingent consideration, such as an earnout, to be recorded as a liability on the opening balance sheet of the buyer.

Is an earnout part of the purchase price?

Generally, an earn-out will be treated for tax purposes as part of the purchase price. However, if the selling shareholder will continue to provide services to the company, it is possible that the amount will be considered compensation for services.

Is an earn-out part of enterprise value?

An earn-out (whether tied to a specific event or some performance metric) can also bridge a valuation gap where buyer and seller disagree on the enterprise value of the business as of the closing. An easily-achievable earn-out can also provide payment flexibility by functioning much like true seller financing.

What is EBITDA earn-out?

Earnout EBITDA means the earnings before interest, taxes, depreciation and amortization of Buyer, taken as a whole, during the Earnout Period, as determined in accordance with GAAP.

How is an earnout treated for tax purposes?

Earnout payments are taxed generally as ordinary income or as purchase price consideration (i.e., capital gain).

Are earnout payments tax deductible?

If the earnout is treated as compensation rather than as part of the purchase price, the purchaser is entitled to a tax deduction for the earnout/compensation payment (subject to payroll tax withholding and, potentially, to the golden parachute and nonqualified deferred compensation rules).

How does the earnout affect the buyer and seller?

The earnout eliminates uncertainty for the buyer, as they only pay a portion of the sale price upfront and the remainder based on future performance. The seller receives the benefits of future growth. Key contractual considerations include earnout recipients, accounting assumptions used, and an agreed-upon time period.

How is an earn out treated for tax purposes?

Earnout payments are taxed generally as ordinary income or as purchase price consideration (i.e., capital gain).

What is an earn out in private equity?

An earnout is a contractual provision stating that the seller of a business is to obtain future compensation if the business achieves certain financial goals. The differing expectations of a business between a seller and a buyer are usually resolved through an earnout.

Is an earnout an installment sale?

Earnouts may be described in various ways, but they usually call for one or more installments of additional purchase price to be paid to sellers when, usually in a later year or later years, the parties can determine whether or not the specified financial results have been achieved or the goals have been met.