Earnouts in Mergers & Acquisitions (M&A) Explained

There are important factors to consider as the buyer or the seller when structuring the terms of an M&A earnout (or earn out or earn-out), which may be critical to the success of your deal structure.
When selling a business, the sales/purchase price can come in different forms. You may get paid as a mix of cash and seller financing, stock in the company, etc.
An earnout is essentially a variable purchase price based on the performance of the business post-closing. If the business meets certain metrics in the hands of the buyer, the seller is paid an additional amount.
As Brett explains, this structure works to align the interests of both the buyer and the seller of the business. But, there are very important factors to consider as the buyer or the seller when structuring the terms of your earnout that are absolutely critical to the success of this deal structure.
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Have questions? Book a call, and talk to Brett today:
clarity.fm/brettcenkus
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You can reach Brett through:
clarity.fm/brettcenkus
/ brettcenkus
/ bcenkus
www.cenkuslaw.com
braatenwoods.com
merger-resources.com
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Brett A. Cenkus has 20+ years of experience in business law, finance, and entrepreneurship. Through Cenkus Law, PC, he provides advice and services for mergers & acquisitions (M&A), securities offerings, founders’ agreements, and other general business law issues.
Through Braaten Woods, LLC, Brett helps business owners in the lower middle market ($2MM - $25MM) position themselves for sale, find buyers, negotiate, and close M&A deals.
Brett also maintains merger-resources.com, a site packed with free articles, videos, checklists, deal diagrams, template contracts, and other tools to help pass M&A knowledge to others.
Brett regularly consults with entrepreneurs and invests his own capital as an angel investor.
From 2010-2013, Brett served as Chief Legal Counsel of a publicly-traded international oilfield services company. From 2001 to 2006, he and a partner founded and built Paragon Residential Mortgage. Bridge Investments acquired Paragon in 2006.
Brett holds a Juris Doctorate from Harvard Law School and a Bachelor of Arts degree in Economics from Messiah College in Grantham, Pennsylvania.
Brett lives in Austin with his wife, Cathryn, and two children. He enjoys reading, squash, classic movies, great food and wine, and the New England Patriots.
#corporatelaw #mergersandaquisitions #businesslaw #corporatelawyer

[@ekowbartels-kodwo9234]

Great video. Learning so much. Thanks a lot.

[@LukeAvedon]

Love all your videos man! Such a smart dude.

[@nicholasfaro]

Wonderful content! Congratulations on the amazing video

[@egziomahrene8063]

Great content and delivery. Thanks for sharing this wisdom. I'm about to start working on a small deal and was wondering what would be other creative ways to structure the deal so as to mitigate risks after closing.

[@davidqquintero1843]

Thank you for the video!! Very informative.

[@BrettCenkus]

You're welcome!

[@sullivanrothmanp.a.4932]

Jesus christ this is gold. All your videos are great.

[@BrettCenkus]

thank you, Andres!

[@jamesk1564]

Please don’t use the lords name in vain

[@bradsemmens8676]

Awesome video mate! G’day from Australia.

[@BrettCenkus]

Thank you, Brad.

[@marcusharding293]

Awesome and succinct.

[@BrettCenkus]

Thank you, Marcus.

[@20evya]

Awesome videos! very helpful and informative. Any chance you can do one on purchase price adjustments? (closing accounts vs. locked box etc.)

[@BrettCenkus]

yes. In fact, I have one "in the can" about that exact topic. We'll get it up soon.

[@BrettCenkus]

Yesterday we posted a video on closing accounts vs. locked box approach. Here's a link - kzbin.info/www/bejne/r5XJpmOipc53oMU. I hope it's helpful to you!

[@butt3rmuffinsis]

What are some quantitative variables that are used to calculate the earnout consideration and performance targets?

[@BrettCenkus]

We see revenue and EBITDA targets used most often. Due to its litigation-provoking nature, we're not huge fans of EBITDA, although it is still a popular choice. Net income shows up (it raises similar concerns to EBITDA). Financial targets are usually set as increases over a baseline (e.g., trailing 12 months before closing, prior fiscal year). I can't point to any "typical" revenue or EBITDA increase amount. Sometimes the target is flat (maintaining the baseline revenue or EBITDA). If I had to guess, I'd say that 10% - 20% increases year over year, something like that, are relatively common. It depends so much on the particular business, though, so don't put too much stock into those percentages (as averages). We often see two earnout measurement periods (e.g., an earnout based on increasing revenue by 10% in the first year post-closing and, separately, increasing revenue by a collective 20% in the first two years post-closing). Occasionally, we use non-financial targets, such as transitioning contracts, launching a new product, or keeping key employees (i.e., successfully moving them to the new business and, with employees, retaining them for some amount of time). When used, I'd say that earnouts account for approximately 20% of the deal value (ranging from 10% - 30%, although we've done 100% earnout deals!), i.e., the upward limit of an earnout would add a max. of 25% to the fixed consideration, e.g., upfront payment of $12MM and possible earnout payments of $3MM. It feels like earnout structures are relatively evenly split between all-or-nothing and graduated approaches. With all-or-nothing, if the buyer clears the target threshold, the buyer pays the full earnout. With a graduated approach, if the buyer hits 50% of the target, the buyer pays a proportionate amount (it could be 50%, it may be scaled a little differently). Similar to how EBITDA and net income earnout targets often lead to disputes, all-or-nothing approaches are risky because a buyer may have an incentive to control the business to come in just below the target. Hence, sellers are upset and suspicious when that happens (even if it happened without any manipulation whatsoever). Brett

[@ThatManSimmonds]

How long should the 'Earn Out' period be? What is the average 'Earn Out' Period?

[@BrettCenkus]

one or two years is common

[@bouchechhamdi816]

a company made 130k euros net profit in 2023 ( net profit here means after paying everything, taxes, salaries, depreciation,etc) and in 2022 made 45k net profit, and in 2024 they are expecting net profit similar to 2023 ( they already made 60% of the same grosss sales as in 2023)....i want to buy this company and i am not sure how much i should offer for the total deal and how much of it should be offered as earnout ? any help here is appreciated , this is a real situation in Germany i have at the moment

[@AlLy-lc9kp]

The seller would be expecting a multiplier of let’s say 3 years min of that profit plus any amounts within the expenses which relate to owner personal earnings. On the second part - the bigger the differed part the better, let’s say 50 % down payment and 25 in two steps after 12 and 24 months…

[@thugly921]

Earnouts, more often paid than earned :)

[@slydog784]

Earnouts are a trap. Pay me now or don’t buy my business.