Earn-outs in acquisitions: attractive on paper, but complex to implement!
In a business acquisition, an earn-out is often agreed upon; a portion of the purchase price is made contingent on the target company’s future performance. The goal may be to bridge a difference of opinion between the buyer and the seller regarding the value of the company.
On paper, earn-outs seem like an attractive compromise. In practice, however, these arrangements often present sellers with challenges related to providing evidence.
There are a few things sellers should keep in mind:
✅ If you do not remain involved in a management role at the target company, you will have no control over the target company’s policies and operations following the acquisition—and therefore no control over the fulfillment of the earn-out triggers. You will be at the mercy of the buyer and the target company’s management.
✅ If you do not specify how the buyer is to contribute to the realization of the earn-out, you can only rely on a best-efforts obligation based on reasonableness and fairness. This means that the buyer (or the target company) is only required to make an effort to achieve the earn-out, but is not obligated to achieve a specific result (the actual realization). This is therefore a very lenient obligation.
✅ It is difficult to prove that an obligation to use reasonable efforts has not been fulfilled, because such an obligation does not guarantee a specific result and because the seller is at a disadvantage compared to the buyer in terms of information regarding the reasons why the earn-out triggers were not met.
✅ If you do make specific agreements, avoid general, open-ended obligations and vague standards regarding what the buyer must do or refrain from doing. Such obligations will still lead to ambiguity and disputes. Failure to comply with them is difficult to prove.
✅ Carefully consider what is needed to achieve the earn-out and include those details in a concrete and specific manner.
✅ According to some court rulings, the interests of the target company take precedence. The target company’s management has discretion, and uncertain future developments may justify policy decisions that could adversely affect the realization of the earn-out.
In short: an earn-out can be a useful tool, but it remains a mechanism with inherent uncertainties. Without clear agreements and a well-thought-out evidence strategy, the seller runs the risk of not receiving the expected additional payment.
If you have any questions about an earn-out (or its fulfillment), please contact us.
