Earn-out clauses for the sale of a business are increasingly common. We look at the positives and negatives that every business owner should consider.
Business transactions often include earn-out clauses where the vendors ‘earn’ part of the purchase price based on the performance of the business post the transaction. Typically, an earn-out will run for one to three years post-transaction date.
There are two main reasons to include an earn-out in a sale:
- To bridge the sale price expectations gap between the vendor and the purchaser. The earn-out represents an ‘at risk’ form of consideration. If the business produces the result, the vendors are rewarded through a higher sale price.
- To incentivise the vendors continuing to work in the business and maintain the growth momentum of the business post-sale.
Advantages of earn-outs include:
- The ultimate sale price has a performance component – both buyer and seller benefit.
- It may assist in achieving a sale where a price impasse would otherwise prevent the sale.
- If the earn-out calculation is transparent and easily measurable, the parties should not dispute.
- Creates equity where the business has lagging income, new business initiatives at the time of sale or a high growth rate.
- The business can effectively fund the incremental sale price out of realised growth.
The key to an effective earn-out is in their construction, both from a commercial and a legal perspective. Get them right, and they can enhance the continuity and succession of a business.
If you’re thinking of selling your business and would like to know more about earn-out clauses, contact us or make an appointment today.