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What should you know about earnouts?

On Behalf of | Jul 18, 2021 | Business Law |

Sometimes, it’s hard for businesses to reach a deal on an acquisition or merger. This is sometimes because of a difference in the valuation of the businesses. One option that some businesses use to address this issue is to set up an earnout as part of the deal.

It’s imperative that anyone who’s considering an earnout as part of a merger or acquisition knows exactly what they can do. An earnout is included in the contracts to require additional payments from the company that’s making the purchase to the shareholders of the other company. These payments are typically earned by the receiving company meeting particular milestones.

What are the pros and cons of an earnout?

The positive aspect of the earnout is that it’s a good bargaining tool that doesn’t require an immediate payout. This can help both parties with the financial aspect of the deal. The party that has to pay the earnout won’t have to produce money immediately. The recipient party can look forward to the earnout as milestones or goals are reached.

The downside of these agreements is that there can often be challenges about whether the terms required from the earnout were properly achieved or if one party jeopardized the terms. In some cases, it can be difficult to come up with the metrics that will be used to determine whether the party gets the earnout.

You should ensure that you fully understand each point that’s included in a merger or acquisition. Having legal guidance with all of your contracts is wise. This is best done early in the process so you have time to address any potential concerns.