Lawyer for business mergers, acquisitions, divestitures and other transactions.

EARN OUT - Business Purchase Agreement

 Business Purchase  -  Letter of Intent  -  Due Diligence  -  Negotiations  -  Asset vs Share  -  Purchase Agreement  -  Closing

Contact Neufeld Legal PC at 403-400-4092 / 905-616-8864 or Chris@NeufeldLegal.com

An earn-out is a contractual provision in a business purchase agreement where a portion of the total purchase price is contingent upon the acquired business achieving specific financial or operational targets (metrics) after the sale has closed. In essence, the seller must "earn" this part of the payment over a defined earn-out period, which typically lasts one to three years.

Earn-outs are important in business acquisitions and mergers because they act as a tool to bridge disagreements and align interests between the buyer and the seller. Their importance is perceptible as:

A. Bridging Valuation Gaps

  • Given that the seller and the buyer often have different expectations about the company's future value, with the seller may have an optimistic view of future growth; while the buyer, focusing on historical performance and current risk, and thus is more skeptical. As such, the earn-out structure allows the buyer to pay a lower, more comfortable upfront price, while giving the seller the opportunity to realize their higher valuation if their optimistic projections actually materialize post-acquisition. This helps get the deal done when a price agreement seems otherwise impossible.

B. Risk Mitigation for the Buyer

  • By deferring a part of the purchase price, the buyer is protected from overpaying for a business whose projected growth or value doesn't pan out. The buyer is only required to pay the contingent portion if the business performs as promised.

C. Incentivizing and Retaining Key Management

  • Alignment of Interests: Earn-outs often require the selling owner or key executives to remain with the company for the earn-out period.

  • Motivation: Tying a significant payout to the company's future success strongly incentivizes the former owners and key personnel to stay engaged, work hard, and ensure a smooth transition and continued high performance for the new owner.

Common Earn-Out Metrics

The specific targets used to determine the earn-out payment are highly negotiated and clearly defined in the purchase agreement. Common metrics include:

  • Financial Metrics:

    • Revenue (total sales).

    • EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization).

    • Net Income or Gross Profit.

  • Non-Financial Milestones:

    • Securing a major new contract or customer.

    • Achieving a specific regulatory approval (common in biotech/pharma).

    • Successful launch of a new product or technology.

A well-drafted business purchase agreement is the foundation of a successful acquisition. It should be a robust document that protects the buyer from future surprises and gives them clear remedies if the business is not as it was represented. For knowledgeable and experienced legal representation when purchasing a business, contact corporate business lawyer Christopher Neufeld at Chris@NeufeldLegal.com or 403-400-4092 / 905-616-8864.

 

Employee Probationary Period