An earn-out agreement is a deal that is struck between a buyer and seller in a business transaction. This type of agreement allows the seller to receive payment based on the future performance of the business being sold. It is a great way for both parties to benefit from the deal and to ensure that the business continues to be successful.
The Earn-Out Agreement Explained
An earn-out agreement is a legal agreement between a buyer and seller, often used in mergers and acquisitions. The agreement specifies that the seller will receive a portion of the sale price of the business based on its future performance. This performance is usually measured over a set period of time, typically one to three years.
The agreement is structured to incentivize the seller to ensure the business continues to perform well, even after it has been sold. The buyer benefits from this agreement because they only have to pay the full purchase price if the business performs as expected. The seller benefits by receiving additional payment for their business if it exceeds expectations.
How it Works
An earn-out agreement allows the seller to receive payment over and above the initial purchase price if certain performance targets are met. For example, if a business is sold for $1 million and an earn-out agreement is included in the sale, the seller may receive an additional $100,000 if the business exceeds certain performance targets, such as reaching a certain level of revenue or profit.
The performance targets are usually set at the time of the sale and are agreed upon by both parties. The agreement will also specify the time period over which the performance targets will be measured.
Risks and Rewards
The risks and rewards of an earn-out agreement are shared by both parties. The seller takes on the risk that the business may not perform as expected, which could result in a lower payment than they had hoped for. The buyer takes on the risk that the business may perform better than expected, resulting in a higher payment than they had anticipated.
Both parties benefit from the agreement if the business performs as expected or better. The seller receives additional payment, and the buyer can be assured that they are getting a good return on their investment.
Conclusion
An earn-out agreement is a great way for both the buyer and seller to benefit from a business sale. It provides the seller with the opportunity to receive additional payment if the business performs well, and it ensures that the buyer only pays the full purchase price if the business meets certain performance targets.
If you are considering an earn-out agreement, it is important to seek the advice of a legal professional who can help you understand the risks and rewards of this type of agreement. With the right advice and guidance, an earn-out agreement can be a beneficial tool for both parties in a business sale.