Firstly the parties need to agree what targets must be achieved to trigger payment of the earn-out. Such targets could be financial, operational or linked to specific event. The length of earn-out period needs to be discussed and agreed. Most earn-outs last between one and three years following completion, but other time frames may be agreed.
Secondly, the details around the earn-out payments need to be discussed. If the earn-out targets are achieved this must be linked to the date of payment of the earn-out consideration. Such payment could be a single earn-out payment at the end of the earn-out period, or by way of multiple earn-out payments made at specified intervals during the earn-out period. The method of calculating the amount of each earn-out payment is also an important consideration. For example, specifying a set amount payable if the earn-out targets are achieved; or, a percentage of the specified earn-out target; or, a multiple of the amount by which earn-out target is exceeded. The amount of the earn-out could also be capped or subject to a minimum.
The earn-out could be paid in cash, or satisfied in non-cash consideration (such as an issue of shares or loan notes in the buyer). Importantly, the seller should ensure there is a default interest provision that will apply if an earn-out payment is not paid on the due date. Under certain circumstances the seller will expect to be able to bring forward the earn-out, such as the sale of the target company or a substantial part of its business.
Thirdly, the performance of the target company needs to be measured. Clear and tangible mechanics need to be agreed so as to determine whether the earn-out targets have been satisfied. This could include the production of financial statements using a specific accounting framework, principles and policies. In the event of no agreement on the financial statements dispute resolution provisions will need to be included in the earn-out documentation.
Fourthly, the seller will want certain protections by way of buyer undertakings. For example, an undertaking not to make any material changes to the business or not to sell the business during the earn-out period. Finally, consider whether the seller requires any security in relation to the buyer’s obligations to pay the earn-out payments, such as an escrow account, guarantee or charge.