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KeyStructuresandRecentDevelopments
June22,2011 PaulCrimmins
13127017068
pcrimmins@mayerbrown.com
BenGray
13127018644
bgray@mayerbrown.com
JessieWaller
13127018761
jwaller@mayerbrown.com
What is an Earnout?
B i D fi i i BasicDefinition:Anearnoutisariskallocationmechanismusedinan
M&Atransactionwherebyaportionofthepurchasepriceisdeferredandis calculatedbasedontheperformanceoftheacquiredbusinessovera specifiedtimeperiodfollowingtheclosing. ifi d ti i d f ll i th l i
Financing:Useofanearnoutinstructuringanacquisitionprovidesbuyerwith
anadditionaloptiontofinancetheacquisition(i.e.,buyermaybeabletopayfor theacquisitionwithfutureprofitsofthetargetbusiness). Thisattributeisparticularlyimportantineconomicclimateswherethirdparty financingcanbedifficulttoobtainonfavorableterms.
IncentiveBasedCompensation:Earnoutscanalsobeusedasaformof
incentivebasedcompensationtosellerswhoarecontinuingasemployeesofthe p g p y acquiredcompany.
Startups:Earnoutsareoftenusedforcompanieswithlittleoperatinghistorybut
significantgrowthpotential(whicharenoteasilyvalued). significant growth potential (which are not easily valued)
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TheEarnout:ADisputePostponed?
Duetothecomplexitiesofstructuringanearnout,earnoutsoftenleadto futuredisagreementsandlitigation. As Vice Chancellor Laster stated in the recent Airborne Health decision AsViceChancellorLasterstatedintherecentAirborneHealthdecision,... anearnoutoftenconvertstodaysdisagreementoverpriceintotomorrows litigationoveroutcome. Notably courts have been willing to use the implied covenant of good faith to Notably,courtshavebeenwillingtousetheimpliedcovenantofgoodfaithto imposeobligationsorrestrictionsonbuyerwithrespecttoitspostclosing operationoftheacquiredbusinessintheabsenceofexpresscontractual terms.
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Buyers Points
Buyer should also add contractual provisions reserving the right to take certain Buyershouldalsoaddcontractualprovisionsreservingtherighttotakecertain actions. Buyershouldincludeanacknowledgmentfromsellerintheacquisition agreementthatbuyerhasabsolutediscretiontooperatethebusiness. agreement that buyer has absolute discretion to operate the business
Yarboroughv.DeVilbissAirPowerInc.,321F.3d728(8thCir. 2003)
Earnoutpaymentwasbasedonlyonsalestocertainspecifiedcustomers. Buyerdiscontinueddoingbusinesswithonespecifiedcustomerand transferredthatportionofitsbusinesstoanother,nonspecifiedcustomer. Agreementstatedthatbuyerhastheright,initssolediscretion,to determinethetermsandconditionsofanyandallrelevantsales,including thedecisiontomakeornotmakeanysuchsales. 8thCircuitfoundbuyerhadexpresslyandunambiguouslycontractedfor absolutepoweroveritsabilitytomakesalesinordertoforeclosesellers claimofbreachoftheimpliedcovenantofgoodfaith.Thecourtaffirmedthe grantofsummaryjudgmentforbuyer.
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Sellers Points
AffirmativeCovenants:Sellershouldnegotiateforaffirmative
covenantsrequiringbuyertoactingoodfaith,usereasonableeffortsandtake everyactionnecessarytomaximizetheearnoutpayment.
RestrictiveCovenants:Sellershouldalsonegotiateforcovenants g
explicitlyrestrictingcertainactions,including,forexample:transferringfixed coststotheacquiredbusiness,firingorrelocatingkeypersonnelandunder capitalizingthebusinessortheR&Dneededforgrowth.
Control:Sellermayalsowanttocontractforacertainlevelofcontrolover
theoperationsoftheacquiredbusinessduringthelengthoftheearnout period(e.g.,approvalrightsovercertainmajordecisions,abilitytoelecta certainnumberofdirectors).
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