Often times, there can be a significant difference between what your business owner thinks her business is worth, and what a buyer is willing to pay. A common issue is that business valuation is a difficult task and simply cannot always be quantified. A creative solution can often take the shape of a simple, well-written Earn-out agreement.
An Earn-out agreement can provide the business seller with the opportunity to prove the worth of her company, or even the growth of the company. This can be accomplished within an agreement that: (1) allows for an initial payment; (2) creates a contractual obligation for the seller to remain with the company during the transition period; and (3) provides an incentive for the seller to enhance the company’s performance during the often-tenuous transition period. The net result is a buyer who no longer has to worry about over-paying, and a seller who is pleased with the post Earn-out price, which they actively helped to achieve. Specifically, the buyer often pays in the vicinity of 60%-80% of the sale price up front, with the balance paid at the end of the Earn-out.
Unfortunately, for a myriad of reasons (many obvious), the Earn-out does not always go smoothly. Clearly, this is a difficult relationship–one which is fertile ground for disagreement on infinite levels, when there is a lot on the line. So, Earn-outs are often avoided–and for good reason. But, when there is no other way to make a deal and please the client, the Earn-out can be an effective solution. However, there are several considerations that must be addressed–while keeping everything as simple as possible–in order to achieve a successful agreement.
A few basic guidelines to address are to keep the agreement simple and limit the payout determination to a few variables that are easily ascertainable. A good example for a small, growing business would be to limit the determination to an expanded client base, or even something as simple as client retention after the sale. This is especially important when the seller’s name or personality could be directly related to customer retention. It is crucial, however, for the seller to limit their Earn-out period participation to conditions that they will be able to control during the Earn-out period. This can be difficult, but with careful preparation and drafting, it is very achievable.
We welcome new clients to contact us for more information on this often ideal solution for selling, or purchasing, a business.
