Reinier advises national and international companies
reinier.russell@russell.nl +31 20 301 55 55An earn-out in the event of a company takeover offers opportunities and risks. The former director and major shareholder remains involved in the company and part of the purchase price remains dependent on future performance. What aspects are important here?
When acquiring a company, it may be wise for the former director and major shareholder (DMS) to remain as a director after the purchase. First of all, the former DMS remaining is important for the continuity of the company. After all, they know the company like no other. Retaining the DMS’s knowledge of customers, suppliers, and internal processes can be crucial for successful continuation. This is valuable for the buyer because it increases the company’s chances of growth. In practice, the remaining in office of the former director is often linked to an earn-out.
An earn-out is an agreement whereby part of the purchase price in a takeover is made dependent on the (future) performance of the company. The unpaid portion is only paid once the company achieves the expected results. It is important that concrete agreements are made about the objectives. Commonly used parameters are turnover, EBITDA (earnings before interest, taxes, depreciation, and amortization), or customer retention. The earn-out period, during which these targets must be achieved, usually lasts one to several years, depending on the agreements.
Accepting the earn-out implies that the former director and major shareholder (who is now a director) has confidence that the agreed targets are achievable. The pitfall, however, is that this person has a dual role: on the one hand, as a director who must serve the interests of the company, and on the other hand, as the seller who has a financial interest in achieving the earn-out targets.
Another sticking point arises when there is disagreement about the earn-out targets. If these targets are not measurable and specifically laid down in the agreement, disputes may arise about whether the targets have been achieved. It is important to make specific agreements about, among other things, the targets set, the duration of the earn-out period, the method of monitoring, and the method of dispute resolution.
Another stumbling block in an earn-out can be that the buyer and seller may disagree about how the company should be managed. The seller will mainly focus on achieving the earn-out targets quickly, while the buyer may have a long-term vision. Clear agreements about tasks and responsibilities are therefore crucial.
Would you like to know how to record agreements about an earn-out in such a way that the risks are limited? Please contact us. We are happy to think along with you and help you avoid risks.
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