Blog

Who gets the benefit of an earn out – shareholders or management?

An earn-out is a provision frequently used in the sale of a business whereby the seller of a business will receive additional payments based on the future performance of the business sold.

The concept of earn outs has merit in that the owner will get paid additional amounts if the business performs after the sale and the purchaser will pay additional amounts based on clarity of certain objectives.

As corporate advisers, we often see earn outs in services businesses, where the selling owner may receive additional consideration for the sale of the business based on the performance of the business after it has been sold.  The common performance criteria may include profits, revenue growth, staff retention, supplier retention and customer retention.

Earn outs may also be required if there is a reliance on a few major customers, suppliers or where a major sale is potentially imminent.

The question is who gets the benefit of the earn out, shareholders or management.  When the shareholders and management are the same people the differentiation is not relevant.  In situations where there are shareholders who are not involved in the day to day operation of the business or key managers that are not shareholders, there is a question as to who gets the benefit of an earn out.

I have had a few situations recently where there are shareholders who are not part of the management team.  Should they get the same benefits as a management shareholder who is obliged to stay with the acquirer for a reasonable period and who will be somewhat responsible for the achievement of an earn out. 

Usually some of the earn out will be attributable to management and some to shareholders. It depends on the particular circumstance for the balance between personal goodwill and business goodwill.  For non-management shareholders it is probably unrealistic to receive all of the pro rate entitlement to an earn out.

There can be rather difficult conversations between shareholders on who gets the benefits of an earn out.  Another good reason to reduce the potential reasons why an earn out may be warranted.

Peter Wallace

Endeavour Capital

Business sales/acquisitions | Business valuations | Corporate Advisory | Exit Ready