The Earn-Out Model Works!!
By Rick Gould CPA, J.D.
The earn-out model has been the gold standard for the 20+ years that I have been doing mergers and acquisitions. It is a proven, fair model used by all major PR firm buyers from holding company firm buyers to mid-size firm buyers to bolt-on firm buyers.
The appeal and benefit of the earn-out model is rooted in the fact that it protects and benefits both buyers and sellers during M&A transactions. The earn-out model stipulates that the sellers of a business are paid for the sale of the company but must remain with the company through a transition period. If the company achieves or exceeds a certain established level of performance, the sellers have the opportunity to receive a larger price from the sale. If the company does not do as well as expected, buyers are protected from overpaying.
There are a variety of earn-out models, including top line earn-outs, EBITDA bottom-line, fixed scale earn-outs and sliding scale earn-outs. Though these models differ, all are contingent on the fact that the ultimate price/value of the PR firm being sold is dependent upon the future performance of the seller.
The Earn-out Model Works for the Seller
• By implementing the earn-out model rather than selling for a fixed price, a seller has the opportunity to receive a much larger price from the sale if the company performs well after the sale takes place.
• The earn-out model is performance-based, which is fair and incentivizing.
• Top-line and bottom-line generated for the seller by the buyer adds to the seller’s ultimate value (and price) of the firm.
• The addition of a buyer’s intellectual capital, management expertise, digital capabilities, back office systems, new business pitch team, RFP team and other features that a seller may not have implemented at the same level, if at all, adds to the value (and price) of the firm.
The Earn-out Model Works for the Buyer
• It protects buyers from overpaying if the company does not perform as well as expected after the sale is made.
• It creates a win-win situation for the seller “and” buyer. If the seller’s income increases based on the organization’s performance, the buyer’s income also increases.
• It makes deals affordable for many buyers who have limited funds to invest in acquisitions.
• It acts as a retention device, requiring key seller staff to remain with the firm in order to receive their earn-out payments.
• It aligns seller management and staff with buyer’s interests.
• It can often be internally financed, rather than financed through a bank.
• It shows the buyer that the seller is willing to have skin in the game and to stand behind their company and their expectations and predictions for its future success.
In my 20+ years of experience doing Mergers & Acquisitions in PR, the earn-out model has proven to be a very effective, proactive model when structured properly. Structuring an effective earn-out model involves:
• Clearly and properly defining the earn-out model
• Clearly and comprehensively spelling out the financial metrics, whether based on top-line and or bottom-line data
• Including examples whenever examples are possible
• Defining the seller’s rights to operational (vs. legal) control during the earn-out period, i.e. hiring and firing, account teams and over servicing
• Defining the buyer’s ability to weigh in on certain major decisions, i.e. new offices and new specialties
• Establishing checks and balances and legal protections for both the buyer and the seller
I am a total proponent of the earn-out model. It is used on Wall Street, and all levels of PR firm buyers use it. It’s fair, beneficial to both buyers and sellers and, most importantly, it works.