If you're in the market to buy or sell a business, you know that valuation is a key part of negotiating. But how you value a business can depend largely on perspective.
A seller might think that their business is on a roll and that it will perform increasingly well post-closing and on into the future. That seller will likely feel that the buyer should pay for that enhanced performance and those future projections.
Conversely, the buyer might be looking to the company's past performance to settle on a sum they're willing to invest. They'll often want to buy based on that past performance and will therefore discount the seller's rosy scenario and promises for future growth.
Depending on the situation, the buyer and seller could end up on opposite ends of a pricing spectrum for a given acquisition target. How can they resolve the difference? It's pretty simple. By using a pricing structure called an earnout, seller and buyer can more readily come to an agreement. In its most basic definition, an earnout enables a seller to "earn" part of the purchase price of their business based on post-sale performance.
Earnouts can be a very helpful tool and an effective technique for bridging the gap between a hopeful seller and a skeptical buyer. It's a simple way to eliminate uncertainty for the buyer and move the sale along while still leaving room for the seller's rosy promises.
Using an earnout, the buyer can buy the business now at a satisfactory purchase price. The seller essentially finances part of the purchase price of their business and repayment of this sum depends on the future achievement of a predetermined level of earnings or growth. It's a scenario in which both parties win. And so long as the language of an earnout agreement is clear and terms are met, both parties can get what they want in the end. Since the final result is based on performance and clear evidence, it can feel like a fair resolution, even for parties that aren't keen on the agreement.
An earnout is a perfect way to bridge what could otherwise be an irreconcilable gap. It narrows the distance between both parties' differences and is one of many tools in the deal maker's tool kit for getting the seller and buyer to agree and close the deal. It's also effective in the case that a buyer both feels that the seller's price is far over the company's value and also doesn't have the necessary capital available to meet that price.
If the deal feels lopsided to either party, an earnout is one way to compensate for that. Using a seller note is another method to bridge gaps if the buyer cannot finance the entire transaction in one go or if the company presents possible challenges to success. In those cases, the seller could agree to accept a majority of the purchase price at the time of sale, and the rest in a series of deferred payments.
At Calkins Law Firm we've been helping sellers and buyers make deals for decades. It's a very rare occurrence that a deal doesn't close. That's thanks to the many tools we have available and our creative use of them on behalf of our clients. More often than not, with a willing buyer and seller and a diverse toolkit at the ready, a deal can be made and closed to everyone's satisfaction.
If you're looking to work with a legal expert who also has undeniable business acumen, Calkins Law Firm has you covered. Reach out to learn more about our team and to discuss your situation.