Earnouts A Study Of Financial Contracting In Acquisition Agreements

An Earnout is a contractual provision stipulating that the seller of a company will receive additional remuneration in the future if the company achieves certain financial goals, usually expressed as a percentage of turnover or gross profit. If an entrepreneur who wants to sell a business demands a higher price than a buyer is willing to pay, an Earnout provision can be used. In a simplified example, there could be a purchase price of $1,000,000 plus 5% of gross revenue over the next three years. In addition to cash compensation, there are a number of important considerations. This includes designating the key members of the organization and including a earnout. The duration of the contract and the role of the manager with the company after the acquisition are two subjects that must also be negotiated. We empirically study Earnout contracts that provide for acquisition payments in acquisition contracts. Our analysis shows great heterogeneity in the potential size of the earnout, the level of performance on which the conditional payment is based, the period over which performance is measured, the form of payment for the Earnout and the overall sensitivity of the Earnout payment to the target performance. Our testing of the determinants of contract duration supports the view that earnouts are structured in a way that minimizes the cost of valuation uncertainty and moral hazard during acquisition negotiations.

Tags: Earnouts, Contingent Payments, Acquisitions Journal of Accounting and Economics is currently edited by J. L. Zimmerman, S. P. Kothari, T. Z. Lys and R. L. Watts Subscribe to this pricing review for further articles on the topic 368B Mervis HallPittsburgh, PA 15260United States412-624-0296 (Phone) 52 Pages Published: May 2, 2006 Last Revised: May 16, 2012. Managerial Performance, Tobin`s Q and the Benefits of Successful Purchase Offers Related Work:This article may be available elsewhere in EconPapers: Look for articles with the same title…