Earn-out clauses can bridge differing price expectations. Without precise provisions, however, they often merely postpone the purchase price dispute until after Closing.
M&A | Company Acquisitions | Purchase Price Clauses | Earn-out | Austria
The seller and buyer are fundamentally aligned on the company – but not on its value. The seller expects strong growth, while the buyer does not want to pay in full at Closing for expectations about future performance. A common solution is an earn-out: part of the purchase price becomes payable only if the company achieves specified financial or operational targets after the sale.
This can effectively align interests. At the same time, it creates a structural issue: after Closing, the buyer will often control the company and therefore, at least indirectly, the developments on which the additional purchase price depends. This is precisely why an earn-out clause requires particularly careful drafting in an acquisition agreement.
An earn-out provides for a variable purchase price component in addition to a fixed purchase price. Whether, and to what extent, this additional amount becomes payable depends on previously defined conditions being met within a specified period. Typical metrics include revenue, EBITDA, EBIT, recurring revenue, specified customer or product targets, or other clearly measurable operating KPIs.
From a commercial perspective, an earn-out may be particularly useful where buyer and seller have different expectations regarding future performance, where the company is experiencing strong growth, or where the former owner remains involved in the business for a transitional period following the sale.
The wording “20% of EBITDA for the next two years” may appear clear at first glance. In practice, however, the real drafting work only begins at this point. In particular, the agreement must specify how EBITDA is calculated, which accounting principles apply and how extraordinary items or intra-group effects are treated.
– Which accounting standards and accounting policies apply?
– May existing accounting or valuation methods be changed?
– How are management fees, group allocations or transfer pricing arrangements treated?
– How do acquisitions, restructurings or new investments affect the calculation?
– Are extraordinary expenses or income to be excluded or normalised?
– How are costs taken into account if the buyer reallocates them to the company after Closing?
The less precise the definition, the greater the scope for interpretation in the subsequent calculation – and therefore the greater the potential for disputes.
The central conflict of interest often arises because the seller remains economically dependent on the company’s future performance while no longer controlling the business decisions. A buyer may, for example, bring forward investments, incur additional costs, relocate business activities or change the way services are charged within its corporate group. Such measures may be entirely commercially justified and yet still reduce the earn-out.
A balanced agreement should therefore specify the degree of entrepreneurial freedom retained by the buyer and which measures are subject to particular restrictions during the earn-out period. From the buyer’s perspective, an obligation to operate the company solely to maximise the earn-out will generally be unacceptable. Conversely, the seller should not be exposed to an outcome that can be arbitrarily influenced by post-Closing restructuring measures.
A seller entitled to a variable purchase price requires sufficient information to verify its calculation. The agreement should therefore provide for appropriate reporting, information, inspection and audit rights. It should also specify when the earn-out statement must be delivered, the period within which objections may be raised and the consequences of failing to meet those deadlines.
The acquisition agreement should not wait until a dispute over EBITDA or another metric has arisen before determining how it is to be resolved. Pure calculation or accounting issues may, for example, be referred to an independent expert or auditor for expert determination. Legal questions concerning the interpretation of the acquisition agreement should be distinguished from such matters and may fall within the jurisdiction of a court or an agreed arbitral tribunal.
A clear allocation is essential: Which issues are determined by the expert, which by the court or arbitral tribunal, and is the expert’s determination binding? Ambiguous dispute resolution provisions may otherwise create an additional dispute as to jurisdiction or competence.
In addition to the calculation itself, the due date and security for the earn-out should be considered. Depending on the transaction, caps and floors, acceleration events in the event of a subsequent sale of the company, the buyer’s set-off rights or security arrangements may be relevant. The agreement should also clarify how warranty or indemnity claims of the buyer affect outstanding earn-out payments.
If the seller remains with the company after Closing as a managing director, employee or consultant, the purchase price should be carefully distinguished from remuneration for the seller’s continued services. What happens to the earn-out if that relationship ends prematurely? Should the outcome depend on which party initiated the termination or on the reason for it? These situations frequently give rise to significant conflicts of interest in practice and should therefore be addressed in the acquisition agreement from the outset.
An earn-out can facilitate a transaction even where buyer and seller have different views of the company’s future value. It does not eliminate valuation uncertainty; it merely reallocates it. An objectively verifiable calculation formula, clear rules governing the operation of the company during the earn-out period, adequate information rights and an effective mechanism for resolving disagreements are therefore essential.
The key question is not only: What targets must the company achieve? It is also: Who can influence after Closing whether and how those targets are achieved?
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