Earnouts are suffering a reputation crisis

Author: Danielle Myles | Published: 30 Sep 2015

General counsel have queried the effectiveness of earnout clauses in bridging value gaps in M&A, suggesting more straightforward economic arrangements may be a better solution.

For the handful of situations in which they are feasible, counsel stress the importance of unambiguous drafting, good tax structuring, and the requisite level of trust between counterparties.

Earnouts are a pricing mechanism whereby a seller receives a portion of the target’s short-term economic upside post-closing, in accordance with a set formula that references the target’s financial performance.

On paper it can seem like a win-win situation; the seller can benefit from higher consideration, which the buyer can pay due to the profit generated by the newly-acquired business. But in reality, they often don’t go to plan.

"I can absolutely see the value in an earnout, and I can absolutely see the theoretical attractiveness of an earnout as a way of...