How do I assess whether an earn-out deal will work for me?

I’m planning on selling my recruitment business. I’ve found a buyer and am negotiating the terms of the sale. Predictably, the buyer doubts my valuation of the company based on future growth projections, but has offered an earn-out as a compromise. What factors do I need to consider and negotiate on before I accept a deal on this basis?

A. Ken Scott writes:

The brutal truth is that almost all company sales/acquisitions are entered into with the best of intentions, yet most fail for the buying side. This is probably why acquirers are keen to lock you in for a period to prove the business really has legs. It’s quite normal, especially in an unpredictable market.

There are a number of factors for the seller to think through. The key one is not to take anything for granted, but to ensure the sale and purchase agreement (SPA) has been properly thought through and drafted, and that it protects your rights. Like any legal contract, the real worth only kicks in if there’s a problem and the relationship between the parties breaks down. That might be the last thing on your mind, but it’s worth investing some real thought into this area. Here are four key issues to consider before accepting a deal:

Recognise the reality

The business will no longer be yours once you sign the SPA. You are selling your ownership for a consideration and you lose control. Whatever your intentions are going into the sale, once the contract is signed, the new owner has rights and responsibilities over what you spent years building. Ensure that you retain ongoing power over the key parts of the business, at least for the period of your earn-out.  This will enable you to achieve your earn-out targets with minimal interference and give you some control. Do some due diligence on the buyers – the people and its culture. Have they purchased before and what is their track record on the behavioural side post-acquisition?

Is the valuation enough?

Does the overall amount the buyer is prepared to pay meet your expectations? Are you satisfied with the earn-out arrangements, and does the total deal provide enough consideration upfront against the incentive of the earn-out? There is no renegotiation once the deal is complete.

Are the earn-out goals achievable?

This is very subjective, but you’re the one whose feet will be held against the fire, so you must be satisfied that you can do what is necessary to meet the targets. As a recruitment business, you are providing professional services and, as such, are highly reliant on key staff. Are you providing sufficient incentives to those individuals you need to help you achieve these goals?

What level of independence will you be given?

Whatever you agree must be written into the SPA, so it’s worth thinking through the worst case scenario and planning accordingly. This will protect you, but also allow you to sleep easier at night.

Ken Scott is chief executive of AIM-listed training firm ILX Group, and was a regional winner in this year’s Ernst & Young Entrepreneur Of The Year Awards.


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