It's interesting to read that the use of earn-outs seems to falling out of favour in US M&A transactions. That's certainly not the case in UK technology acquisitions, where they remain as popular as ever as a method of bridging the gap between what a buyer wants to pay and the seller's expected valuation.
Earn-outs in M&A transactions - where the purchase price is split between a payment at closing and one or more contingent payments dependent on certain targets being met - are seen as an easy method of fixing the price retrospectively. They also have many perceived benefits for both the buyer and the seller. The buyer only pays the "full" price (the amount the seller wants) if the target business lives up to expectations and performs, and the earn-out ensures management retention and incentivisation. For the seller, an earn-out is a simple method for dealing with any price disagreements with the buyer and provides the target company with an opportunity to prove itself whilst part of a larger group with access to resources - such as a buyer's sales channels - that would otherwise be unavailable to it.
However, in practice, earn-outs are rarely structured in a way which gets around the fact that the goals of the buyer and the sellers are diametrically opposed. As most earn-outs are tied to some financial metric (such as EBITDA of the target) the sellers will want to maximise short-term growth, whilst a buyer is generally looking for the target to grow into a long-term viable business.
One way around this would be to focus on integration as the key earn-out mechanic. All studies show that the key to M&A success is getting the integration right post-completion of the deal. If the earn-out is structured around meeting integration milestones, this could be a win-win for both the buyer and the sellers.
Earnouts Are Less Common An earnout is compensation that the seller can receive after closing that is linked to the future performance of the company and its ability to meet and exceed specified targets. In 2018, 14% of transactions included an earnout as compensation, a decrease from 2017 when 32% of transactions included an earnout. While earnouts are less common, they provide the buyer with an opportunity to reduce closing payments, especially for companies that are younger and still growing. On the other side, an earnout can permit the seller to benefit from the future growth of the company. Earnouts can help bridge a valuation gap between the buyer and seller, lowering the closing purchase price while simultaneously providing compensation to the seller should the company’s growth continue.