The earn-out is a source of strife and litigation. In the United States, 20% of deals have an earn-out clause, 36% of which end in litigation, according to the Grant Thornton M&A Survey 2023.
The earn-out is an agreement that allows the seller to receive additional payments in the future, at least if the company shows favorable results. These earn-out payments are thus based on the company's future performance. However, these agreements often lead to differences in interpretation and legal proceedings between buyer and seller.
An earn-out arrangement comes about because the buyer and seller have different expectations about the future of the business. The buyer sees mainly the risks and applies a conservative, moderate growth rate of, say, 5%. The seller emphasizes the opportunities and counts on a high growth rate of, say, 10%. This gives a higher value but also a lot of uncertainty.
The buyer is only willing to pay this increased price if these results are actually delivered. Seeing is believing. The seller agrees if he is convinced that these results will actually be realized.
The buyer makes a distinction between the value of the cash flows and the assets that belong to him after the acquisition. We call this the "transferable value. The buyer assumes that this value is relatively 'certain' and he is willing to pay a purchase price for it.
All capital gains above this transferable value are uncertain and based on the seller's high expectations. This value is realized only if the market is very positive, growth is high and uncertainties or setbacks are limited.
The buyer must take into account the seller's interests, that is, the buyer must set policy and strategy in such a way as to maximize the chances of paying the earn-out. But the buyer owns the company and will do its best to limit these earn-out payments. The buyer has been given an incentive precisely not to meet the forecast.
Conclusion
In all of these cases, buyer and seller must reconvene to come to an agreement. Lawsuits over such financial disputes are complex and lengthy. It is often legally difficult to find out exactly what was meant by the contracts. As business, financial and tax skilled mediators, we can help you come to an agreement.
