David Young is a Partner at DLA Piper (http://www.dlapiper.com/). In this video he discusses the earn-outs of selling your business.
- Earn out: a portion of the payment upfront, with the remainder paid out over time
- For a seller, focus on something easy to measure
When people are looking to sell a company, there is generally or there is often a difference in perspective on valuation from what the buyer thinks the business is worth versus obviously with the seller think the business is worth.
Sometimes that leads the deals not happening and the one most common way to bridge that gap is through what’s called an earn out where basically there is a certain amount of the purchase price typically upfront. But then, the rest of the purchase price sometimes in the incremental portion sometimes aligns fair. Sometimes basically all of it is spread out over a period of years based on the company’s performance in the hands of the buyer.
And this is a way that that difference in opinion sort of that valuation gap can be bridged is by basically if the business does what you say it’s going to do, then you’re going to get the purchase price that you want.
It’s very important from the seller’s perspective and how that structure -- it’s generally viewed as something that’s dangerous because people often – their expectation often are not met. It’s often not what they were hoping, and so this sort of way these formulas are calculated in just what it’s based on is very important and often more important than people think.
Typically for the seller, you want to really have it – try and have it just be focused on something that’s very easy to measure. Top line revenue for example is far preferable to something where there is a profit component because once you are in the hands of a buyer as a part of a larger company, it’s not clear which is expenses are really expenses of your company. You might be asked to fly to New York for some general company business, but that hits your own company’s financial statements.
There’s a whole host of reasons where interests suddenly aren’t aligned. And so keeping it simple and really focusing on the details focusing on the formulas, how it works and really making sure that you’re comfortable, that it’s something that you’ll be able to hit the minimal amount that gives you what you want.
So, obviously if you’re going to get a certain purchase price, ideally you’ll get it upfront. If you can’t then earn out can be a useful to get the purchase price that you want. You just need work closely with your advisers and make sure that it’s structured in a way that it is what you think it is.