Risks to Buyers When Devising Earn-Outs
Earn-outs are a common method of potentially compensating sellers in M&A transactions. Payment of a portion of the (potential) purchase price must be earned in accordance with the agreed terms before it becomes due. Earn-out provisions must be carefully contructed and are typically subject to detailed negotiations so that the parties agree on as many variables as possible.
For example, if the earn-out is dependent on the future performance of the just-acquired business over the earn-out period, is the buyer even required to maintain such business over such period (or maintain certain staffing levels, or allow the seller to continue to run the business, or use commercially reasonably efforts to maximize performance .....), or does it have complete flexibility to run its business as it sees fit? If the allocated portion of the buyer's overhead will be higher than the acquired business before acquisition, should the earn-out results be adjusted to compensate? Who calculates that annual perfomance that gets measured against the earn-out metrics? .....
Here is a link to an article prepared by Gibson, Dunn & Crutcher on certain risks surrounding earn-outs, including a new Delaware Chancery Court decision. See:
http://www.gibsondunn.com/publications/Pages/Delaware-Chancery-Court-Decision-Underscores-Risks-to-Buyers-When-Devising-Earn-Outs.aspx?utm_source=IA&utm_medium=email&utm_campaign=alert
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