Advantages and Disadvantages of Earn Out Provisions
Mitch Biggs is a Featured Business and Finance Contributor on Associated Content. This is a reprint of a previously published article.
What businesses are great candidates for earn out provisions? Typically the earn out provision is a great solution when there is considerable goodwill baked into the selling price, low asset and high cash-flow businesses that are experiencing growth and when businesses have had good growth followed by a poor year due to external economic forces with aggressive growth forecasts.
Seller advantages and disadvantages using earn out provisions. The seller can start their clock ticking on their exit strategy for the business and take the business off the market. There will be full disclosure with employees about transfer of control rumors and a smooth transition with the new ownership. The disadvantage is they get part of the value at closing and then must deliver the terms of the earn out provision to be paid the balance of the business value without being the boss.
Buyer advantages and disadvantages using earn out provisions. The buyer is able to feel comfortable with the agreed upon price that is usually more in-line with company assets lenders love for financing. Any quibbling over the anticipated growth of the company is left on the seller’s shoulders to deliver as part of the earn out provision. One disadvantage of earn out provisions for buyers is that they are limited as to what they can do with the company during the earn out period. The seller must retain enough interest to meet the demands of the earn out provision.