June 2025 Newsletter – Earn-Out Agreements
EARN-OUT AGREEMENTS
WHEN SELLING OR BUYING A BUSINESS
COMPLEX, COMPLICATED, AND LENGTHY
Having represented many business clients for forty plus years, a critical issue that continually and constantly comes up is the sale of the business when there are no children to replace a parent/owner near the end of his/her life. This issue becomes more complex, lengthy, and troublesome when the original owner lists the business for sale and cannot receive the purchase price that he/she believes the business is worth. When there is a purchase price deadlock in negotiations, an experienced business attorney may recommend the discussion of an Earn-Out Agreement. By definition, an Earn-Out Agreement is a financial arrangement in which a portion of the purchase price for the business is contingent upon its future performance allowing the seller to benefit from the business post-sale with payments ranging from one to five years post-acquisition.
Earn-outs are typically used in mergers and acquisitions (M&A) to break purchase price deadlocks or to bridge the valuation gap between the buyer and the seller. The seller can receive additional compensation based on the business performance or key performance indicators after the sale. For example, the additional compensation is often linked to specific financial thresholds or metrics such as revenue targets, profit margins, net profits, gross margin or EBITDA. The goal or intention of the business attorney is to align the interests of both parties, especially when there is uncertainty about the business’s future performance.
Advantages of Earn-Out Agreements are reducing the risk of overpaying, incentivisation and flexibility. This office constantly warns buyers that the risk of overpaying for a business is based on optimistic projections that may not materialize. The purchase price needs to be reduced and the M &A agreement must be tailored to fit the specific circumstances of the transaction, allowing for adjustments and modifications based on how the business actually performs post-acquisition.
For example, with an earn-out provision, the seller and key management may be motivated to continue driving the business’s success after the sale as the increased purchase price is tied to financial performance. With the above variables the typical Earn-Out can be tailored to fit the specific performance of the transaction allowing for adjustments based on the business’s actual performance.
As you can infer, structuring Earn-Outs agreements can be complex, complicated and lengthy requiring experience, careful negotiations and clear documentation to avoid disputes later on. Why? Additional earn-outs payments based on relevant performance periods are typically paid in “cash” ranging from one to five years after the relevant performance period.
In summary, Earn Out Agreements ae a valuable tool in M&A transactions especially during periods of economic uncertainty, when sellers and buyers have differing expectations about future performance. Thus, retention of an experienced business attorney, proper structuring and clear communication are essential to ensure both parties’ interests and success is aligned to minimize potential disputes.
If you want to discuss this complex complicated use of Earn Outs and understand the benefits and risks as it applies to your business, feel free to contact Joseph R. Pozzuolo, Esquire at Joe@Pozzuolo.com or direct dial at 215-977-8201.