Posted on: 26-01-2020

Earn-out scheme

Written by:

Marcel van den Ende

Advantages and disadvantages of an earn-out scheme

One of the ways of financing the purchase of a Netherlands company is an earn-out scheme. This can be a solution if the buyer is unable to pay the full purchase price immediately. The earn-out is therefore regularly discussed during negotiations between buyer and seller.

What is an Earn-out?

An Earn-out arrangement is an arrangement in the purchase agreement, about the future payment of (a part of) the purchase price, often also related to the operating income realized in the future.

There are various ways to formulate an earn-out. In most cases, the purchase price is determined during the negotiation process on the basis of the value of the assets and the company. The payment of the purchase price is then spread out over several years.

The installment payments are then linked to the profit of the company. If the profit is high, more is paid. If the profit is not that high, the payouts are lower and it takes longer for the loan to be paid off.

For example, if a buyer and seller match the purchase price of a company of € 1.50,000, then the seller can agree with the buyer that € 750,000 is paid on the closing date, and the remainder in annual installments, related to a percentage of the net profit of the company.

Parties can agree on a minimum amount or maximum amount for each year. For example, parties can agree that in the first year, the minimum payment equals 10% of the net result before interest, taxes, depreciation and amortization (EBITDA) and no less than € 150,000. The second year a minimum of € 200,000 can be set and so on. The better the performance of the company, the faster the loan financed by the seller is repaid.

The seller's responsibility during an Earn-out

Although the buyer has the responsibility to pay the seller, many earn-out agreements require the seller to remain involved with the company or offer advice or other assistance during the earn-out period.

Keeping the business owner involved with the business has several advantages. It can ensure that the transition goes smoothly, the new owner can still use the knowledge and experience of the previous owner and it gives the seller the opportunity to ensure that the business continues to run well, so that the proceeds can be used for payment of the purchase price.

Good contracting

It is wise to clearly include the seller's responsibilities, the reciprocal obligations and the length of the transitional period in the purchase agreement. Parties must have a good idea of ​​what they can expect from each other here.

De advantages and disavantages of an earn-out scheme

The benefits of an Earn-out

Earn-outs offer benefits for both the buyer and the seller. From the buyer's point of view, the financing of the purchase price is spread over a period of years, making it easier to pay for the business sale. Because the payback time is linked to income, the buyer can pay less if the income is not high.

The seller also has advantages, such as the fact that the transaction is effected, while without the arrangement that might not have been the case. Furthermore, repayments will be made quickly if good results are achieved. Finally, the seller who remains connected to the company will receive a fee for his consultancy work.

The disadvantages of an Earn-out

Earn-outs also have disadvantages for both buyer and seller. The presence of the seller sometimes can be disruptive to change processes. There may also be disagreements about the policy to be pursued, especially if the profit comes under pressure. The two captains on one ship situation can also lead to a lack of clarity among staff.

From the seller's point of view, the obvious disadvantage is that the income may not be high enough to repay this financing quickly. Sometimes the sold company is not doing well at all, or even goes bankrupt. It is important for the seller that the earn-out scheme offers sufficient protection, such as a minimum purchase price to be paid or a clause that makes it possible to take back the shares if the buyer does not comply with obligations under the purchase agreement.

Get advice if you are considering an earn-out scheme

Minerva Advocaten regularly assists buyers and sellers in the purchase and sale of a company. Are you considering an earn-out scheme? We know the pros and cons of the earn-out and can act quickly if needed. We know the ropes in the Netherlands jurisdiction. If wished, contact us and tell us about your situation without obligation. We like to help you. Our motto is not for nothing: "Your problem, our concern."

More information?

Marcel van den Ende will gladly help you further.

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