Earn out

An earn-out clause defined in a contract of sale as a percentage of the purchase price that is paid at a later date based on performance. Such clauses are found mainly in acquisition agreements.

Base

Earn-out clauses can be based on different performance measures, usually this is but an economic variable that is either taken directly or calculated on the basis of the profit and loss account (as well as real variables are alternatively as sales volume used ). Find an earn - out clause applies, the purchase price was allocated in a base purchase price ( for the shares ) and one to be designed by the earn-out clause additional purchase price. The base purchase price is paid to the transition date, whereas the additional purchase price will be paid at a later date depending on the achievement of the defined in the earn-out clause success sizes. Problematic are earn- out clauses, especially in the cases where the seller has little or no influence on or control over the tax base. The buyer may be tempted in such situations to manipulate the design value to the detriment of the seller. Furthermore, it appears in practice that too acquirer is usually fully integrated on the share transfer in the buyer company. The accurate determination of the tax base of the earn -out is thus partly problematic as a separate, clear-cut success determination in this case can not be made.

Motivation

By far the most common reason why parties receive an earn - out clause in an acquisition agreement, have different expectations about the future profitability of the company. At different expectation regarding future profitability may, for example come with new technologies that have not yet penetrated the market. In addition, find earn- out clauses apply if a high degree of uncertainty regarding the development of the company is (eg in turnaround situations in start-up companies or previous years without commercial success ). With an earn-out clause a distribution of risk between the parties takes place. Earn outs are also used to bind a seller who has agreed to stand for the sale of the company, the new owner still as managing available to the selling company.

Economic character

In economic terms, make earn-out clauses constitute a right of option ( see Option (economics) ): the seller receives in the event of a positive development of the basis of assessment of the earn-out clause, an additional payment. The value of this option can be determined by methods of financial option pricing theory.

Legal character

Legally, it is in an earn-out clause is a conditional purchase price. With a contingent purchase price, derogation from the law risk allocation. The law provides that all economic benefits and risks go with the transition on the new owner. Through an earn-out clause but the old owner still participates after the transition in the economic success of the company sold.