Business Owners Looking To Sell In The M&A Market

Business owners looking to sell in the M&A market within the last year may have faced a few new issues. First, the lack of available debt financing has reduced sales activity. Second, valuations were at a historical high, but are rapidly decreasing with the current state of the economy.

One way buyers and sellers have bridged this gap is through the use of an earn-out as part of the purchase price. An earn-out is a provision that defers and conditions a portion of the purchase price to the satisfaction of specified milestones.

The earn-out may be very useful to achieve the sale on terms favorable to Buyer and Seller. But, the Seller should beware of a few issues and nuances related to the earn out that may have grave future consequences.

First, what are the terms of the earn-out? An earn-out based on the gross revenue may be the most beneficial to the Seller because it has the fewest calculations to be manipulated. An earn-out tied to net revenue may benefit Buyer as a "truer" test of the success of the company; but changes in cost of goods sold, variances in accounting methods and non- recurring expenses associated with a change in ownership may further lower net revenue calculations.

Second, what is the management structure after the purchase and during the "earn-out"? The owner will want to retain the management team that produced this prosperous company in order to achieve goals and get maximum return on the earn-out. New buyer will want control over the purchased company. These two differing perspectives can be negotiated after term sheet and prior to sale- but they should be considered! Seller may use an employment agreement tied to the terms of the earn-out to ensure continued participation. Voting agreements will also maintain Seller review of the actions of the Board of Directors. The terms of any earn-out tied to employment by the company must also be reviewed for tax consequences, to ensure capital gains treatment to the earn-out as opposed to ordinary income from employment.

Tredway, Lumsdaine and Doyle attorneys have experience in negotiating the ever-changing and evolving world of mergers and acquisitions of closely held companies. If you have questions about selling your business, please call us for further guidance

Article Submitted By: Attorney Brooke Pollard