Mergers and acquisitions lawyers are currently facing intricate deal-making processes, as clients continue to embrace a tool that allows buyers to delay paying the full purchase price of an agreement. This tool, referred to as an earnout, is being utilized to resolve the challenges of establishing a mutually agreeable price, given that it permits buyers to compensate sellers at a later date, contingent on the attainment of certain preset milestones.
According to Liam Timoney, a private equity and M&A partner at Goodwin Procter, the popularity of earnouts has seen a dramatic upturn in recent years. “I’ve literally seen an earnout involved in every deal I’ve worked on in the last year,” Timoney stated. “If it’s not been ultimately featured, it’s still definitely been considered, and it’s been part of the negotiation.”
In a sluggish economic climate, earnouts prove to be particularly beneficial. They serve to bridge the gap between what buyers are willing to pay for a company and what sellers expect to receive. Moreover, they safeguard buyers by requiring certain benchmarks to be met, and ease their financial obligations by eliminating the necessity to pay the full amount upfront. As reported by Bloomberg, there were $80.2 billion in deals involving contingency payments in the past year.
Despite an overall decline in deal volume and count, largely due to an unfavorable economy for transactions, earnout numbers have persisted in exhibiting strength. Marissa Wiley, a partner at Nixon Peabody, conveyed that following the onset of the pandemic, almost all the deals she has worked on have included earnouts.
However, earnouts prolong the pace of transactions and potentially increase the time lawyers must devote, consequently adding to billable hours. Time is allocated to defining milestones, devising calculations that receive unanimous consent, and establishing the accounting practices employed by the buyer.
With the trends showing a rise in disputes regarding earnouts and M&A, extra precision and caution are called for during negotiations and drafting of these deals. Despite the proliferation of disputes, a surge in lawsuits associated with earnouts is yet to be observed, indicating parties are succeeding in negotiating disagreements. Wiley advises sellers to be content with the money they receive at closing, treating any additional earnout pay as a “bonus” rather than a given.
Given the increasing complications arising from the use of earnouts, the role of legal counsel in M&A deals becomes even more crucial. By advising on the fine details of the negotiations and ensuring the successful execution of the agreement, these professionals remain on the frontlines of this evolving field.