Earnout payments for deals that were settled recently are unlikely to be paid as vendors see their businesses come under unprecedented pressure from the global financial crisis. As an indirect result, we’re seeing a lot of conjecture around the fairness of earnouts. Vendors are asking, why are we carrying your future risk after we’ve absolved ourselves of the business’s future profits?
The apathetic response is one referring to legal terms, the agreed contract and the unfairness of life. However, having a remorseful vendor is a terrible outcome for a multitude of reasons. So, it’s important to communicate the concept of earnouts in a way that doesn’t portray unfettered avarice on the part of your firm. The lucky part is that earnouts really do have their place and tend to be quite fair. Here are the two main reasons:
With all of that said, the simplest way to communicate the fairness of earnouts is in terms of risk and reward. An earnout allows a buyer to pay a higher reward by reducing the risk. (The risk is that the vendor negatively influences the business, or doesn’t drive the business as hard, during the hand-over period.) I don’t for a minute buy the idea that an earnout should protect the buyer from economic and market movements. They are risks in any business and the new owner should be solely responsible for absorbing the outcomes.