Buying and Selling a Business
Sharing Future Risk and Reward with an “Earn Out”
In many transactions for the purchase or sale of a business, due to the uncertainty of future value that often comes with such transactions, we often use a tool called an “Earn Out” as a technique to allocate future risk and share in the potential future upside of a transaction. An Earn Out is a contractual arrangement between the parties that pushes into the future (sometimes up to 5 years) a portion of the consideration flowing to the Seller and generally includes additional sharing of some upside with the Seller for extraordinary performance. The Earn Out can be based upon one or more uncertain factors such as future market performance, revenue, expenses, income, client retention and/or employee retention, just to name a few. The trick is to strike a proper balance between risk and reward of the certainty of value and the uncertainty of future business; the more uncertain the future, generally the higher the Earn Out as a percentage of purchase price. A recent legal seminar put on by the Mergers and Acquisitions Section of the Houston Bar Association, presented by UHY, LLP – CPAs highlighted the inherent tax and accounting issues associated with use of an Earn Out due to Purchase Price Allocation requirements of accounting standards (ASC 805) and the classification and timing of financial reporting of the Earn Out. These issues, when coupled with the very intricate contractual terms associated with an Earn Out, require experienced legal and tax assistance to avoid common pitfalls such as certain disagreements as to Earn Out calculations and/or detrimental tax treatment for one or both of the parties of the allocated amounts. The Strong Firm P.C. works with both Buyers and Sellers of businesses on transactions large and small which include these and other creative ways to get business transactions accomplished.
Bret L. Strong
Phone Number: 866-912-8639
Fax Number: 281-210-1361