I have been involved in many business sales, and find that earn-out clauses can be a very useful tool to unlock a dispute over the sale price and to secure a sale. 

However, I would like to share my experience of a case that should stand as warning to future vendors when relying on earn-out payments.

Never underestimate the value of a well framed contract!

In this case, the buyer agreed to an earn-out payment based on the following year’s profit figure, and the seller chose to step away from the business completely, leaving the new business owner to run the business from day one. 

Fast forward 12 months to when the seller was expecting their first earn-out payment, and the seller received a rude shock, indeed.  

During that first 12-month period, the new owners decided they needed to engage various external consultants to analyse the business, and this resulted in restructuring costs, more consulting fees along with redundancy payouts for staff made redundant due to the restructure. 

After the 12 months, all these additional expenses had completely consumed any profit the business could have made.  Come time for the first year earn-out payment, the seller didn’t receive a penny!

I was asked to look into whether the seller’s approach could be challenged.  In my opinion this issue could have been avoided had the contract limited the buyer’s flexibility on how he ran the business based on the pre-sales operating conditions.  That would have ensured the buyer was not allowed to deduct all these additional costs at the expense of the seller’s earn-out figure.

When framing the earn-out clauses it is vital to consult an experienced accountant to minimise the scope for the buyer to manipulate the accounts in their favour.    

To find out more about our expert determination services we offer, please click here and I’d be happy to have a ‘commitment free’ discussion about your issue. 

Regards, 

Charles Lazarevic