CONTINGENT CONSIDERATION (EARN-OUT)
Pre-Acquisition - Letter of Intent - Due Diligence - Share Purchase / Sale - Asset Purchase / Sale - Merger - Equipment
Contact Neufeld Legal for business mergers and acquisitions at 403-400-4092 or Chris@NeufeldLegal.com
Contingent Consideration (or Earn-Out) is a dynamic component of a business acquisition where a portion of the total purchase price is not paid upfront at closing, but rather is deferred and conditional upon the acquired business achieving specified performance milestones in the future. This mechanism fundamentally shifts risk from the buyer to the seller, allowing the acquirer to commit only to a price that is justified by realized, post-acquisition performance. While the upfront consideration (often cash or shares) is fixed, the contingent payment introduces a variable element that makes the final consideration paid directly dependent on future financial success or operational achievement, providing a structured way for the buyer and seller to agree on a purchase price despite differing views on the target company’s true value and growth prospects.
The primary driver for employing contingent consideration is bridging the valuation gap. Sellers, particularly those in high-growth industries like biotech or technology, often hold optimistic projections regarding their company's future revenue, profitability (EBITDA), or product development success. Buyers, often adopting a more conservative stance due to integration risk or market uncertainties, may be reluctant to pay for this optimism entirely at closing. The earn-out solves this impasse by allowing the seller to achieve their desired valuation, but only if they prove their projections correct after the deal has closed. Furthermore, it serves as a powerful incentive mechanism, motivating key selling shareholders or management who remain with the acquired entity to stay engaged and focused on value creation during the specified earn-out period.
Structuring a contingent consideration arrangement requires careful definition of the metrics, payment period, and payoff mechanics. Metrics typically fall into two categories: financial (such as year-over-year revenue growth, net income, or gross profit) and non-financial (such as obtaining a regulatory approval, securing a cornerstone contract, or completing a key research and development phase). The payoff structure may include thresholds, where payments only begin after a minimum target is met; caps, which limit the maximum payout; and sliding scales, where the payment amount increases linearly or non-linearly with performance. The complexity of these terms necessitates clear legal drafting to prevent post-closing disputes regarding measurement, calculation, and the buyer’s control over the acquired entity’s operations.
When it comes to the legal component of corporate mergers & acquisitions, that is when our law firm comes into play. Such that when your business is seeking knowledgeable and experienced legal representation in orchestrating and completing business mergers, acquisitions and divestitures, we are capable of providing such strategic legal advice and direction. Contact our law firm at Chris@NeufeldLegal.com or 403-400-4092 to schedule a confidential initial consultation for advancing your business' transactional objectives.