Earn-out clauses for the sale of a business are increasingly common
We look at the positives and negatives that every business owner should consider.
Business transactions often include earn-out clauses where the vendors ‘earn’ part of the purchase price based on the performance of the business post the transaction. Typically, an earn-out will run for a period of one to three years post transaction date.
There are two main reasons to include an earn-out in a sale:
To bridge a gap in the sale price expectations between the vendor and the purchaser. The earn out represents an ‘at risk’ form of consideration. If the business produces the result, the vendors are rewarded through a higher sale price.
To incentivise the vendors who are continuing to work in the business and maintain the growth momentum of the business post sale.
Advantages of earn-outs include:
The ultimate sale price has a performance component to it – both buyer and seller benefit
May assist in achieving a sale where a price impasse would otherwise prevent the sale
If the calculation of the earn-out is transparent and easily measurable, there should be no dispute between the parties
Creates equity where the business has lagging income, new business initiatives in play at the time of sale or a high growth rate
The incremental sale price can be effectively funded by the business out of realised growth.
The key to an effective earn-out is in their construction, both from a commercial and a legal perspective. Get them right and they can enhance the continuity and succession of a business.
With a wealth of experience in top-level management, business consulting, mentoring and government advisory roles, Collins Hume Senior Business Adviser Nathan McGrath can bring his unique blend of skills and insights to your business.
Don't wait for tomorrow; now is the time to start working on your business. In his role, Nathan urges businesses to seize the moment and prioritise their growth. Call Nathan today on 02 6686 3000 or click to send an email:
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