The Merits, Risks, and Possible Unintended Consequences of Earn-Outs

May 11, 2023

by an investor from Harvard University - Harvard Business School in Toronto, ON, Canada

When acquiring small or medium sized businesses, buyers often utilize a tool called an “earn-out”, which is a form of contingent consideration that sellers may receive at some point in the future in addition to the cash that they stand to receive at closing. Though earn-outs can be useful and mutually beneficial tools for both buyers and sellers under the right circumstances, without careful structuring and consideration they can fraught with risk and unintended consequences.

Before you propose an earn-out as part of your own acquisition, I’d encourage you to think through some of the risks and considerations that we discuss in today's episode. Please enjoy!

The Merits, Risks, and Possible Unintended Consequences of Earn-Outs

Reply by a professional
from Dartmouth College in Los Angeles, CA, USA

Earnouts are tricky to draft and often lead to disputes as to how to calculate (good drafting helps here but does not head off all disputes). The best earnout provisions contain details about what metrics are included or excluded (one-time expenses, buyer-specific expenses etc.). They can also restrict the buyer's ability to make certain financial decisions to avoid a claim of manipulation of the earnout mechanic. Still can be useful in certain situations.

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