Earn-out clauses are also regarded as a tried and tested means of harmonising different ideas of the sales price in the case of a company succession. But caution is advised: the so-called ’sales turbo’ harbours many pitfalls and can backfire for the seller if used in a dubious manner. Especially in the current crisis, which is accompanied by buyer restraint, earn-out clauses positively support company sales and help to price in future risks. Here you can find out what every company seller should pay attention to.

What are earn-out clauses anyway?

In principle, earn-out clauses are about splitting the total purchase price into a fixed base purchase price and a variable component. In theory, an agreed fixed sum ?X? flows into the seller’s coffers quickly after conclusion of the contract. The variable component, however, is negotiated separately by the two parties. The buyer of the company pays this only when the agreed targets have been met. In this way, the buyer gains time and finances part of the purchase price from the future earnings of the acquired company.

So much for the theory. You guessed it: the variable component can cause a lot of headaches for the seller.

Serious advice pays off

This is because, in contrast to the fixed basic selling price, the company still has to earn the variable component. This part of the purchase price is usually linked to the fulfilment of conditions. Which target is agreed, whether it is realistic and appropriate, such as a defined turnover target or the acquisition of a certain number of new customers in period ?X? etc., is negotiated by the contractual partners in advance.

Avoid defining so-called “hatchet rules”, such as hard-defined turnover thresholds. If the turnover is even one euro below the agreed threshold, the earn-out is cancelled. In practice, the agreement of turnover corridors in connection with so-called “cut-off models” proves to be fairer and less conflictual.

Occasionally buyers try to negotiate profit targets as a basis for calculating earn-out clauses. In practice, we want to avoid this, as profit is much more flexible than comparatively hard sales or new customer targets through clever cost management.

Experience shows that it helps both sides to involve an experienced moderator at this stage at the latest. He knows the advantages and disadvantages of certain earn-out models, recognises emerging conflicts early on and can resolve them amicably for both sides based on his negotiating experience.

Earn-out clauses tend to be a buyer’s tool

The decisive point, however, is that if the agreed target is not achieved, the variable component can also be dropped completely.

Earn-out clauses thus turn out to be a buyer’s instrument in the sale of a company. This is because part of the entrepreneurial risk remains with the seller for a limited time after the successful sale. The earn-out then acts like a bonus, since the buyer pays the variable component only after the target has been achieved. The variable component that initially remains with the seller of the company is thus financed by the buyer from the ongoing profits of the acquired company.

Why will earn-out clauses become more important in the future?

Earn-out clauses are used in the sale of companies especially when the future economic development of a company is difficult to predict. This was more often the case with start-ups, but also when a traditional business depended heavily on the personalities involved there.

In our daily practice we see that earn-out clauses are currently playing an increasingly important role in company sales of all sizes. This trend was already visible before the Corona pandemic and was caused in particular by the beginning cooling of the overall economic outlook. With the economic slump at the beginning of the second quarter of 2020, these became part of most company sales. We expect this to continue for a while as the number of companies for sale slowly but steadily increases.

What to do as a seller?

If an earn-out is part of your negotiations, it is advisable to position yourself clearly with fixed demarcation lines vis-à-vis the buyer. This is because you are then negotiating an economic risk for which you are responsible for a limited period of time, with usually decreasing rights of co-determination and powers in the company.

On the other hand, a change of perspective is also worthwhile. Because in one specific project, the desired integration of earn-out clauses was justified with the following words: “We are always happy when we pay out an earn-out. Because then the project has been worthwhile for both sides.”