When selling a company, the transaction's payout structure can significantly impact the seller's financial future and working environment. One common payout structure involves an earnout agreement, where the seller receives a portion of the sale price upfront, with the remaining amount contingent on future performance metrics.
Earnout Structure
Typically, an earnout arrangement involves an initial payout of around 80% of the sale price at closing. The remaining 20% is paid over an agreed period, subject to meeting specific financial and operational benchmarks. These benchmarks can include revenue targets, EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization), or other performance metrics.
Operational Benchmarks and Earnout Metrics
Earnout metrics vary but often include a combination of revenue and earnings. For instance, in 2023, 64% deals included revenue as an earnout metric, while 62% included earnings or EBITDA. The typical earnout period is around 24 months, although this can extend up to five years in some cases.
Working for the Acquirer
Post-sale, the former owner often continues to work for the acquiring company, whether it's a private equity firm, a strategic buyer, or an internal buyer. This shift can be challenging, as it involves adapting to a new corporate culture and operational structure. The seller must align with the acquirer's strategies and performance expectations, which can influence the success of the earnout.
Potential Challenges
1. Cultural Integration: Transitioning to the acquirer's management style and corporate culture can be difficult. Sellers used to independent decision-making may find the new environment restrictive.
2. Control and Influence: Post-sale, the seller may have less control over business decisions, which can impact the ability to meet earnout benchmarks. This loss of control can be frustrating and may affect the overall performance and satisfaction.
3. Performance Measurement: Clear and mutually agreed-upon metrics are crucial. Disputes can arise if the benchmarks are perceived as unfair or if the seller believes that the acquirer's actions are hindering performance.
4. Financial Implications: The contingent nature of the earnout can create financial uncertainty. If the benchmarks are not met, the seller may receive less than anticipated, affecting financial planning and stability.
An earnout can be a valuable mechanism to bridge valuation gaps and align interests between the buyer and seller. However, it also introduces complexities that require careful negotiation and management. By understanding the structure, potential challenges, and mitigation strategies, sellers can better navigate the post-sale landscape and optimize their transaction outcomes.