The earn-out clause is a widely used contractual mechanism in M&A transactions, playing a crucial role in risk management and aligning the interests of the buyer and seller.

This contractual provision stipulates that a portion of the company’s purchase price will be paid at a later date, contingent upon the achievement of predefined performance targets.

The main objective of the earn-out is to balance expectations: it allows the buyer to mitigate risks associated with uncertain performance forecasts and offers the seller the opportunity to maximize the received value if the targets are met.

In practice, structuring the earn-out clause involves defining clear and measurable performance indicators, such as EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization), net profit, sales volume, or market share. These indicators serve as benchmarks for evaluating the achievement of goals over an assessment period, typically ranging from two to five years after the transaction’s completion. The additional payment may be made in cash, equity interests, or other assets, depending on what has been previously agreed upon by the parties.

From a legal standpoint, drafting the earn-out clause requires rigor and precision to avoid future disputes. It is essential that evaluation criteria are objective and verifiable, ensuring transparency in the assessment process.

Additionally, the degree of the seller’s involvement in the company’s management during the earn-out period must be clearly defined, along with operational limitations for the buyer to prevent potential result manipulations that could hinder goal achievement.

Including effective dispute resolution mechanisms, such as mediation or arbitration clauses, is also fundamental to ensure the stability of the contractual relationship.

Several factors must be carefully considered during the negotiation of earn-out clauses, namely:

• Precedent conditions for the right to payment, including objective reference criteria and compliance with non-compete clauses.
• Definition of the earn-out period, evaluation methodology, value, and calculation formula.
• Procedures for verifying and validating financial results, with independent audits if necessary.
• Stipulations, limitations, and restrictions regarding the management of the acquired company during the earn-out period to prevent changes that could impact results.
• Adjustment and correction mechanisms in the evaluation base calculation, ensuring clear and verifiable criteria.
• Establishment of adequate guarantees, such as partial deposits in escrow accounts, bank guarantees, or issuance of sureties, to ensure compliance with obligations.
• Clear definition of procedures and deadlines for the additional payment.

Ultimately, the earn-out clause offers significant benefits by balancing the buyer’s protection against financial risks and incentivizing the seller to contribute to the company’s growth.

However, its implementation requires special attention due to the complexity in defining and evaluating performance indicators, the potential for conflicts of interest, and the risk of result manipulation through management interference.

Therefore, it is crucial to establish objective, transparent, and well-structured criteria, ensuring balance between the parties and the agreement’s effectiveness.

The of  has extensive experience in M&A transactions and has a specialized team of lawyers ready to advise you on these matters.