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What is an earn-out?

What is an earn-out?

An “earn-out” refers to a contractual agreement in the context of company acquisitions or mergers. It is an arrangement whereby a portion of the purchase price for a company is paid at a later date and under certain conditions. These conditions often relate to the financial performance of the acquired company after completion of the transaction.

Here are the basic steps and features of an earn-out:

 

  1. contractual agreement: When a company is sold, a contract is drawn up that sets out the terms of the earn-out. This typically includes the duration of the earn-out period, the performance targets to be achieved and the amount of the additional payments.
  2. performance targets: The earn-out mechanism usually includes certain performance targets that the acquired company must achieve after the closing of the transaction. These targets can be of a financial nature, such as sales or profit targets, or operational targets.
  3. additional payments: If the acquired company achieves the specified targets, additional payments, over and above the original purchase price, are made to the sellers.
  4. duration of the earn-out: The time frame for the earn-out can vary, but is usually one to several years. This depends on the specific circumstances of the transaction and the industry.

 

Earn-outs are often used when the exact value of a company is difficult to predict or when the buyer and seller have different assessments of the company’s future performance. This agreement makes it possible to share the risk between buyer and seller and incentivises the employees of the acquired company to continue to work successfully to achieve the agreed targets.