Although popular during normal economic scenarios, during times of uncertainty buyers craft earnouts to reduce the potential risk in a deal.
For those of you that have not attended one of our growth and exit planning conferences, an earnout is basically a contractual arrangement where the seller of a business agrees to take part of the buyout of his/her company in contingent payments based on future levels of revenue, earnings, client retention, employee retention, and many, many other metrics.
A well-crafted earnout can actually benefit a seller (assuming that the forecasted expectations become reality and are adequately compensated for in the agreement). Unfortunately, the reverse is also a very real possibility – a poorly structured earnout, one where the seller has little control and/or inadequate auditing of success, can seriously impact the ultimate payout to the seller.
So, it is vital to have professional representation by your side to guide you through any earnout negotiation – especially during these volatile economic times.
Earnout provisions are making a comeback as investors try to address the market uncertainty caused by the coronavirus pandemic. Earnout provisions allow buyers to defer a portion of a deal’s purchase price over a period of time and tie the remaining payouts to performance milestones agreed to with the seller.
Although they are most commonly used in life sciences deals, earnouts in 2019 accounted for 22% of deals outside of the life sciences space, according to a report published by SRS Acquiom.
I would anticipate once 2020 is tabulated, earnout provisions of all sorts will have made up even more than 22% of deals in all industries.
And the length of the timeframe for the earnout can vary as well. According to the WSJ over 70% of the earnouts tracked were between 1-5 years. That means that a seller is on the hook for performance metrics for a long, long time.
Again, this is why having professionals working on your behalf is so important as you negotiate with buyers regarding any type of deal structure. If you are not a professional dealmaker and you have not successfully sold a company in the past, trust me, you need guidance to prevent a buyer taking advantage of you with an earnout scenario that ultimately hurts your total payout.
Some key questions you should consider as you discuss an earnout scenario include:
Ultimately in a win-win earnout negotiation, you will be able to exert meaningful input and have a direct impact on your final payout. Of course, the goal of any earnout is sharing risk. You share the risk with the buyer about the assertions you and your team have made about the future, and the buyer shares with you the risk that these things may not occur.
This is why we strongly insist that our clients create accurate and meaningful projections for revenue and profit going forward. If your company has been growing 5% per year and has a profit margin of 10% for the last 10 years, suddenly projecting 20% growth and margins improving to 30% will only force an earnout upon you. This is especially true in our COVID-impacted business world.
As we have discussed before, EBITDAC recasting (earnings before interest, taxes, depreciation, amortization, and COVID) is very legitimate IF you can accurately document the impact that COVID has had on your business and the strategies you have implemented to overcome the impact of the pandemic on your operations. Both are key and again, highlight just how vital professional representation is when you plan to exit your business.
Our team has closed well over 900 transactions and we are well on our way to the 1K mark. We are able to monetize our clients’ businesses no matter what economic cycle we are in because of the skills of our deal team and their dedication, persistence and hard work.
Just don’t take my word for it – listen to what a few of our clients have said about our services:
In conclusion, I will say this to you: If you want to MAXIMIZE your ROI when you exit your business, you need to hire professionals. Don’t go cheap – realize that your financial future is worth more than you can imagine.
Carl Doerksen is the Director of Corporate Development at Generational Equity.
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I must say that I have never worked with a more driven, competent and focused individual as Don Ho.Jay Dinnison, Owner of Sharpe Mixers
Michael worked tirelessly, He followed every lead meticulously and urgently to make sure nothing was missed.Robert Evans, President and CEO of Mealtracker Dietary Software
We were happy to see the interest in our company and what we cherished has not just a valuable company but an important company to the communities we served in.Larry Moore, Owner, A Company Portable Restrooms
I would like to thank you and your firm, Generational Equity, for being our valued advisors in our journey.Bil MacLeslie, CEO, ipHouse
Thanks again Phil and feel free to have a future client call me if they would like a referral. You are a true professional!Andy Graham, Vice President, Modern Heating & Plumbing
I need to say an immense thank you to Don Ho for his stellar work ethic, attention to detail, and tireless effort. Also thank you to the whole crew at GE! Without you, Don could not do such a phenomenal job. We were shooting for closing and funding before the end of 2020, due to the uncertainty of the political landscape and taxes. I am happy to report we closed last week and will be funding tomorrow.Dr. Caty J. Catron PhD, RN, VA-BC – Owner, Vic The Picc, LLC
We knew it would be a difficult task to have someone really understand our business and our market, prior to researching a possible buyer, so it was imperative that we found someone of your caliber, with definite proven experience in this area.Rick Nowak, President/CEO, Kurz Electric Solutions, Inc.
Tom Staszak is one of the most professional people I have dealt with in my last forty years of business. You’ve got a great group of people and you have built a truly professional organization.Michael J Polarek, President, Paragon Packaging
Dear Chris and Andre, I just wanted to say thanks for all your help. Even though this process was not an easy one, it was comforting to know that I had a capable team standing beside me. You made me feel like we were almost your only client or at least the most important one. Thanks again, and I will recommend your service in the future.Shenille Engelhart, Owner – CLS Technology
We thank you Eric and Generational Equity making our dream come true.Larry Moore, Owner, A Company Portable Restrooms
Thank you again for all your guidance and support. Any company will achieve what they intend, if they have you on their team!Rick Nowak, President/CEO, Kurz Electric Solutions, Inc.
We are extremely pleased with the way Generational Equity handled the sale of our company. Your associates, Tom and Chris, did an outstanding job of getting us (me) through the process.Michael J Polarek, President, Paragon Packaging
I couldn’t have asked for a better team than Michael and Deborah. We couldn’t have done it without them.Robert Evans, President and CEO of Mealtracker Dietary Software
The process was much more involved than I expected and your help, experience and advice was a big factor in making the negotiations go as smoothly as possible.Terry D. Wickman, President, Keytroller
We will highly recommend Generational Equity and Musa Jagne to any business owner about to embark on the same process.Karen S. Williams, CFO, BW Manufacturing
Bruce and I wanted to take this opportunity to thank Generational Equity for assigning Musa Jagne to our transaction. In Bruce’s words, “Musa did one hell of a job for us!”Karen S. Williams, CFO, BW Manufacturing
T.D., thank you so much! You are a great leader! I love how you are using your gifts and talents to better others. You are clearly a GREAT COACH! This 3 day session undoubtedly changed the future of our business, and very well may have been the sole catalyst to save my company, my health and my marriage! A genuine “thank you” from the bottom of my heart.Bryan D. Horn, Owner, Over Under Clothing
We are very happy with the end result, and are very happy to be able to move forward with all of our future growth plans.Rick Nowak, President/CEO, Kurz Electric Solutions, Inc.
I wanted to write you a quick letter to express our appreciation and our delight on the outcome of helping us through the process of our recent sale. We are very happy with the end result, and are very happy to be able to move forward with all of our future growth plans.Terry D. Wickman, President, Keytroller
I am pleased that I was able to work with Andrew Byrd throughout this experience. From the first meeting we had in Minneapolis I felt that I was in good hands. His knowledge and expertise is second to none. He guided the process consistently throughout. I feel lucky that I was pared with Andrew and could not be happier that I chose Generational Equity to handle this major life event. Thank you Andrew and GenEq for everything!Eric Erlandson, Owner, Action Fastenings, Inc.
Generational Equity educated and informed us – so that we could be on the upside of a good decision (to sell).Bil MacLeslie, CEO, ipHouse
Your wisdom and experience were invaluable to me during this once-in-a-lifetime transaction.Ralph Noblin, President of Noblin & Associates
Generational Equity’s assistance was invaluable in compiling and marketing our business.Bil MacLeslie, CEO, ipHouse
Greetings Mike. Thank you for the captivating and compelling presentation you made at the Phoenix presentation last week. Over many years in business yours was the most informative and well-presented presentation, on any subject, that I have ever attended! Your energy and enthusiasm combined with your concise and captivating support of your positions with easily understood examples and data was compelling.Pete L.
The help you provided us during each step of this process made us feel very comfortable and confident we were selecting the right approach to transition our Company.Andy Graham, Vice President, Modern Heating & Plumbing
I quickly recognized that Don was working for Sharpe Mixers above all else, and held our interests above others.Jay Dinnison, Owner of Sharpe Mixers
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