Following the first part of our series on structuring earn-out agreements, which established how to choose the unit of measurement for your earn-out, our second piece now looks into the importance of knowing your company’s growth potential before you enter negotiations. While determining the right metrics forms the foundations of your deal structure, this is arguably the most important aspect in getting the full return when you exit your company.
Why is that? Because without an accurate estimate of your company’s current finances and what these will look like in the future, how will you be able to set realistic targets to fulfil your earn-out? Simply put, you can’t.
For those who missed part one, here is Axial’s definition of an earn-out agreement:
If a significant percentage of the agreed price for the business you have spent years nurturing is reliant on its performance post-sale, you can’t rely on guesswork when setting your expectations. While part one focused in on the importance of simplicity, here a comprehensive understanding is required to ensure you are set achievable targets post-acquisition.
How much is your company worth? And how much will it be worth in five years’ time? Buyers will want to know this information regardless of what structure your exit takes, as it shows them your business is worth investing in. As most entrepreneurs have around 90% of their personal wealth tied into the company they own, it is also important you have a clear idea about its true value and whether that will fulfil your financial goals.
In earn-out negotiations, this understanding of your business growth potential takes on another, vital meaning: it becomes the difference between realistic expectations and impractical expectations. If you project that your company’s annual revenue is estimated to increase from $3 million to $5 million in the next three years, you would not enter an arrangement where you need it to reach $7 million to receive the full price for your business.
So, how do you value a company? It starts by contacting a dedicated M&A advisory firm, like the professionals at Generational Equity. Starting with an all-inclusive survey of your finances and analyzing your growth history, we provide accurate growth estimates on important measurements, such as top-line revenue, net income, and overhead expenses. Through this, buyers will not be in a position to underbid for your business, and you will be armed with the knowledge you need to approach an earn-out confident in achieving the targets set.
Don’t back yourself into a corner with your expectations like in the recent case of Vista Outdoors purchase of Jimmy Styks, LLC. The previous owners, facing a June deadline for this 2016 earn-out, planned to personally buy enough stickers between them to boost earnings past $2.5 million, triggering a $10 million stipulation. Unsurprisingly, this attempt to manipulate the numbers in this manner led to a court dispute in the favor of Vista Outdoors.
Lack of knowledge and over-confidence should be avoided from the outset to avoid setting goals which you cannot possibly reach. By taking the necessary time to apply all relevant valuation methods, establish what your growth potential is and discuss these with dependable advisors, you are far more likely to set realistic expectations and eliminate much of the risk associated with earn-out agreements.
Hopefully, you’re now confident about establishing a practical deal structure for an earn-out agreement, allowing you to be more flexible when organizing your business exit strategy. In part three, we will examine your role in an earn-out and getting clarity about where you will fit in your business post-acquisition.
Alternatively, if you can’t wait for the next part, you can learn everything you wanted to know about earn-out agreements at one of our informative executive conferences. Held throughout North America, these offer an invaluable insight into the M&A process, including techniques for business valuation, growing the value of your company, and exiting with assurances on you and your family’s financial future.
Please don’t hesitate to contact us for more information. We look forward to meeting you soon.
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 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
I would like to thank you and your firm, Generational Equity, for being our valued advisors in our journey.Bil MacLeslie, CEO, ipHouse
Generational Equity educated and informed us – so that we could be on the upside of a good decision (to sell).Bil MacLeslie, CEO, ipHouse
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
Your wisdom and experience were invaluable to me during this once-in-a-lifetime transaction.Ralph Noblin, President of Noblin & Associates
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.
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
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
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.
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
We thank you Eric and Generational Equity making our dream come true.Larry Moore, Owner, A Company Portable Restrooms
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
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
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
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.
Generational Equity’s assistance was invaluable in compiling and marketing our business.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
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.
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
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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