During the merger and acquisition process, the buyer and seller must agree on the value and price of the sale. 

Since one business is acquiring another the price has to be commensurate with the current market value, the value of the business as it stands, and account for debt, risk, and potential changes in valuation post-closing. Needless to say, it can be a tedious process with many complexities and moving parts. Equipping your team with an experienced specialty consultant can make a big difference for the result of the purchase or sale of your business.

This article discusses and defines the issue of earnout disputes, such as when there is a conflict or disagreement about the price associated with the sale of a business. It also describes a few ways to mitigate the concerns related to earnout disputes and how to avoid common pitfalls that arise during mergers and acquisitions.

What is an Earnout Dispute?

During the merger and acquisition process, the buying business and selling business must agree on the value and price of the sale. 

This will include factors such as:

  • Market value
  • Post-closing accounting data
  • Working capital true-up

In many cases, there is a disparity between the agreed-upon price of sale of the business and the actual value of the business at the time of sale. 

To avoid these issues, the seller should meet certain performance metrics to complete the sale at the agreed-upon value.

Since one business is acquiring another business the selling price must be commensurate with the current market value, and the value of the business as it stands. The valuation should account for debt, risk, and potential changes in valuation post-closing. 

Earnout Dispute Pitfalls

Although there may be an initial agreement on the price of the business after some negotiation, post-sale conflicts about the exchange can still arise. These are called earnout disputes. 

It is a good idea to avoid these common issues by preparing a plan in advance for how these business challenges can be handled.

Earnout Provisions

Earnout provisions are a good way to mitigate issues of disagreement of price and value.

They create specifications for what will happen if the terms of the contract are not met. 

This often occurs when the projected value of the company was exaggerated. Sometimes this happens when the value of the company is distorted due to factors outside the company’s control, like changing market conditions.

It can also be related to retaining employees after the sale, which is why it is important to continuously support performance improvement and develop company culture

While retaining employees post-sale can be a stipulation included in the contract, there is no guarantee that employees will choose to remain with the company.

Incentivize the Seller

In some cases, once the business owners have a signed contract their commitment to the stipulations of the sale, or maintaining the success of the business, falls away. It’s important to include certain incentives to the sellers to give them a reason to continue putting forth effort into the successful running of the business. 

A few ways to incentivize the seller include:

  • Establishing performance targets (strategic objectives)
  • Financing the acquisition over time
  • Tax deferrals 

Accurate Accounting

Often, either the seller or the buyer will develop the initial calculations for earnouts using an internal accounting team or an accountant they are familiar with. However, it is a good idea to choose an unbiased, third-party accounting firm for both sides of the transaction. 

Both the seller and the buyer should vet the accountants and agree upon their methodology, technique, and approach.

By choosing an unaffiliated accountant, both the buyer and the seller stand to gain the most benefit from the earnout transaction and have a smooth transition during the turnover process.

Share the Risk

A good way to ensure that the deal can go through according to established negotiation points is by distributing the risk evenly between the buyer and the seller. 

Since there is concern about the future performance of the company for the buyer, it’s imperative for the seller to accurately represent the business in all of its aspects including financials, function, and projected value.

The buyer should ensure that the seller is truly committed to the long-term success of the business enterprise before beginning negotiations.

Speciality Consulting Services

In some instances, the seller is aptly committed to continuing to support the success of the business, but due to external factors, or over-projection, the business does not hit the established metrics.

For this reason, it’s incredibly important to take a synergistic approach in defining the terms of the earnout. A specialty consulting firm will be a great ally during the sale of a business and an earnout, especially before it becomes an earnout dispute.

If there are discrepancies between the initially agreed-upon terms, Hunter Stevens LLC can provide experienced support to alleviate the issues of the earnout dispute. 

A consulting team like Hunter Stevens LLC can help avoid tedious litigation processes and act as a nonpartisan representative to deliberate on new terms and conditions for the sale. 

By contracting the support services of a consulting firm, both the buyer and seller will feel confident that the earnout dispute will be resolved justly. 

Earnout Dispute Support with Hunter Stevens LLC 

Our team is prepared to facilitate the sale of a business, even in complex situations. 

We are here to provide expert support from the initial drafting of the purchase agreement for the sale of a business to confirming performance and stipulation completion post-sale. 

Ultimately, the best way to avoid an earnout dispute is to do your due diligence at the outset before signing any contracts and work with a specialty consulting team that can effectively audit and negotiate for your best interests. 

If your enterprise needs merger and acquisition support or earnout dispute support, the Hunter Stevens LLC team is here for you.