What is an earnout note?

An earnout is where a portion of the purchase price is paid after the closing, contingent in whole or in part on the target company’s financial performance over a specified period of time. Earnouts are common in about 80% of acquisitions and typically represent about one-third of the total transaction value.

What is an earnout calculation?

Simply stated, earnout value is equal to the probability of success, or of each possible outcome, multiplied by the amount to be paid given the outcome. Usually, the company assesses the probabilities and then applies a discount based on the time value of money and the probability that the company is unable to pay.

How do you account for earnout payments?

The earnout is measured by present valuing the expected payment. The present value is recorded as either equity or as a liability. If the earnout is for a fixed dollar value, then the present value is recorded as a liability and measured at fair value going forward.

Is an earnout debt?

Earnouts can be beneficial to both borrowers and lenders. They provide a tool that can mitigate the risk for both borrowers and lenders of overpaying for acquired assets. Earnouts no doubt have debt-like characteristics and lenders will seek to monitor and regulate the leverage and liquidity of their borrowers.

Which is the best definition of an earnout?

Key Takeaways. An earnout is a contractual provision stating that the seller of a business is to obtain future compensation if the business achieves certain financial goals. The earnout eliminates uncertainty for the buyer, and the seller receives the benefits of future growth.

What should be included in an earnout agreement?

The purchase agreement and earnout should be structured to specifically include language on how these matters will be addressed. As a Seller, you need to realize that you will likely not have the same amount of financial and operating control as you did prior to the transaction as this is no longer your business.

How does earnout work for buyer and seller?

Lastly, earnout payments are often treated as additional purchase price and therefore may not be deductible to the Buyer in the same manner as compensation payments. Both Buyer and Seller should consider the tax impact of the earnout and determine whether an alternative structure results in a more favorable tax position.

What happens when the Earn Out is uncapped?

This result is not limited to situations where the earn-out is uncapped in amount. It can also occur as a result of an earn-out provision that has a stated maximum amount and even where an escrow agreement delays the payment of a portion of the purchase price.