Earnouts can be structured into M&A purchase agreements to bridge a gap between buyers and sellers when they have differing views of expected future earnings. Generally, they are structured to tie future payments to future performance over a 2 or 3-year period of time. These are not to be confused with roll-over equity, which is a topic for a future Deal Note.
For sellers who believe their business is worth more than the market will bear and are willing to assume some risk regarding the future performance of their company post sale, earnouts can be an intelligent way to bridge the gap. Most prospective middle market A&D buyers are comfortable with a modest earnout being structured into the deal, typically tied to revenue or EBITDA. While over 80% of the deals that we have done in our 21-year history had their earnouts paid in full, this is not the industry norm. Depending on which study is cited, earnouts tend to have a payout rate closer to 50% historically.
Accordingly, while earnouts can be a great way to structure a sale when the buyer and seller have differing views of value and near-term future performance, they are risky. While our experience exceeds industry expectations, on average, earnouts tend to be paid in full only half of the time.
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