Best Practices for Earnout Structures in Rollups

September 15, 2021

by a searcher from University of Notre Dame in Dublin, OH, USA

We are looking at a potential acquisition in an industry where earnouts are very common. As a complication, this opportunity would also be ideal for a rollup (or at least a couple add-on acquisitions in the near-term).

With this in mind, can anyone suggest any resources regarding best practices for structuring an earnout in this situation?

The concern is that if the earnout were subject to static EBITDA thresholds, then the Company would be motivated to make a lot of add-on acquisitions (regardless of quality) to get over the EBITDA threshold.

Given this setup, how could the earnout be structured to accommodate future add-on acquisitions without being overly complex or creating perverse incentives.

Appreciate any thoughts and/or resources. Thanks

Reply by a searcher
from University of Notre Dame in Dublin, OH, USA

^redacted‌ ^redacted‌ -- Thanks for this suggestion. There might be a way to make this work, though in this particular case the add-ons would be more like tuck-ins -- i.e. we would seek to centralize certain operating functions, moving them from the add-on to the platform.

Said differently, the vision would be for the tuck-ins to provide local sales and customer support in their geography while the centralized platform HQ would process the work.

Reply by a professional
from IE Business School in Denver, CO, USA

Depending on the way you are rolling up the company: ie: assets only, equity etc. Could you consider the bolt-on companies as subsidiary divisions and tie the earnouts to a specific segment of the business? Meaning, if I were an automobile company who bought a tire manufacturer, base the earn-out only on the amount of tires sold and not the overall earnings of the automobile company.

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