Earnouts are used in acquisitions and divestitures to bridge the gap between competing valuations created by the uncertainty in the oil and gas industry. This uncertainty depresses valuations which lead to fewer transactions. While the mitigation of all uncertainty is not achievable, conceptualizing an earnout as a tool to combat market inefficiency can assist practitioners in drafting appropriately tailored earnout provisions that allow transactions to take place and reward risk-taking.
An earnout is a form of consideration that is payable post-closing contingent upon the satisfaction of specified facts or conditions. It affords a seller a higher potential purchase price with a quicker closing and reduces the chances that a buyer will “overpay” or be left with insufficient liquidity after closing. However, it comes at a cost. Both parties maintain exposure to the asset and each other, increasing the risk of disputes regarding the earnout. For earnouts to reduce market inefficiency, they must be tailored to the assets, risks, and businesses involved.
