Seller note vs Earn-out

searcher profile

August 25, 2022

by a searcher in Hồ Chí Minh, Thành phố Hồ Chí Minh, Việt Nam

Hi fellow searchers,

What is your experience with offering seller notes and earn-out scheme? Which is more receptive from your pov?

We are speaking to a few owners in Vietnam and they dont seem to be huge fans of seller notes while they are more willing to consider an earn-out scheme.

Thanks,

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commentor profile
Reply by an investor
from IESE Business School in Calle de Núñez de Balboa, 120, 28006 Madrid, España
This is an interesting question. Obviously each transaction will have its own particularities and will make one option better than the other, or even a mix of the two may make sense.

In general and to align the objectives of seller and buyer, an earn-out is usually my preferred option. It is a consistent way to, for example, even out discrepancies in business valuation. I tend to prefer to align the earn-out with EBITDA, but in any case, the earn-out should be structured as clearly as possible to avoid problems in the future.

An earn-out is a sign of confidence on the part of the seller, as he is relying on the cash-generation capacity of the company he is selling. But it is not so much a commitment to growth and the achievement of the business plan shown in the purchase process.
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Reply by a searcher
from Heriot in Toronto, ON, Canada
The choice arises from cash available to close and optimizing the use of future available cash. For the operations it is about future cash flow. The certain cashflow drain of a seller's not versus the possibility of no cash flow drain at all or higher cash flow drain from an earn out. Proper modelling and structuring to balance is critical. The additional cash flow drain of an earn out may also affect the exit price. Earn outs often address specific uncertain risks that cannot be easily mitigated, whereas seller note's usually address inadequate cash to close. Apportioning the risk between the each of the two usually results in a win-win. Whether one uses either or both ultimately comes down to finding the correct math that makes buyer and seller equally dissatisfied.
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