This is part of a series of articles on transactional contracts issues by Prof. Michael L. Bloom and students in the Transactional Lab at the University of Michigan Law School.
In a private acquisition, a deal can be difficult to strike when there is a mismatch between each party’s valuation of the target business. Perhaps axiomatic: sellers prefer higher valuations; buyers prefer lower. An earn-out offers one means of bridging the valuation gap.
An earn-out makes a portion of the purchase price contingent on contractually defined future events—typically, the acquired business meeting specified objective performance targets for a defined period after closing. With an earn-out, a buyer delays the delivery of some of the purchase consideration and, then, only if the acquired business performs up to contractually specified snuff. A seller might ultimately receive more deal consideration with an earn-out than without but will have to stick around post-closing to find out. Throughout the term of the earn-out, the seller remains interested in the performance of the business it just sold and, so, likely concerned about activities that might affect what the seller stands to gain under the earn-out.
As a result, the seller will often negotiate for contractual restrictions on how the buyer may act with regard to the acquired business during the earn-out period.
Change of Control
The occurrence of a change of control (e.g., merger, sale of stock) of the acquired business (or the buyer) might materially affect the seller’s earn-out prospects. For this reason, it is common to see provisions alongside earn-outs that restrict the buyer from entering into transactions that would cause a change of control before the earn-out period ends or the earn-out consideration is fully paid.
