Consideration for the sale of shares or assets will typically be cash or shares in the buyer (or a combination) but may include debt instruments such as loan notes.
An "earn-out" may be used where there is deferred consideration which is to be calculated with reference to the future performance of the target business, and is an especially prevalent provision when the seller of shares is to continue to manage the target business following completion. This usually entails linking the earn-out consideration to profits (and less commonly to net assets or turnover). Identifying the profit to be taken into account when determining earn-out consideration is crucial.
Both buyer and seller have respective interests that the profit is not artificially inflated or reduced. These concerns will be addressed either by placing contractual controls on the actions of both parties (if the seller remains with the business post-completion) during the earn-out period or by removing any increase or reduction in profit as a result of particular occurrences from the earn-out calculation. Typically the agreement will specify that the buyer will adhere to an agreed business plan in order to ensure that the business continues to be run in its ordinary course.
Procedure for calculating
It is common for the buyer’s auditors to produce draft accounts, setting out the earn-out due for a certain period, which are then forwarded to the seller. The seller must state within an agreed time period whether agrees or disagrees with the calculations and its accountants will be given access to all relevant information to allow them to verify the calculations. Failure to state agreement or otherwise within the time frame will be deemed acceptance of the buyer’s calculations. It is therefore standard for earn-out provisions to encompass the appointment of an independent expert to determine the level of earn-out due to the seller in the event that the parties cannot reach agreement themselves.