9th March 2020
When you come to sell your business there will probably be a difference between the price that you think your business is worth and the amount that a buyer wishes to pay you. A possible middle ground is to negotiate an ‘earn out’ which is a structure whereby, on the sale of a company, you receive an initial amount and then further sums will be paid dependent on the performance of the business following the sale. An earn out is also useful in a situation where a new business has not yet fully established its profitability or track record.
If you agree to an ‘earn out’ arrangement, you will be required to remain as a paid employee of the company, and your conduct during that period will be on certain agreed terms.
This is a way of the buyer protecting their investment. It makes sense to the buyer to do this – if your business is as good as you claim, then both parties will win.
If you are considering selling your business, it is vital that you plan your exit strategy accordingly. The calculation of an earn out will centre around the criteria by which your business’s performance will be measured, and how and when further payments will then be paid, assuming your business meets those targets.
You must also seek advice on your personal tax position, in particular whether you qualify for Entrepreneurs’ Relief. The way that HMRC treats the taxation of earn outs can be extremely complicated.
Make sure that you know your facts and figures, and think about your parameters:
Remember that after the earn out period ends, you will no longer have the salary benefits and other perks of your business. Plan what your life will be like after you have received the money.
While experts can help you to decide what your business is worth, only you know whether you have the appetite to work in the business with a loss of control and under very different conditions. It does not suit everyone, and for some it is better to settle for a potentially lower amount of money in order to achieve a clean break.
It may be possible for a seller to negotiate a more lucrative deal with an earn out, as both buyer and seller benefit from the future success of the business. The risk in relation to future performance is shared. The buyer may be prepared to pay substantially more than a fixed price deal. The structure, however, will ultimately be dependent upon the bargaining power of the respective parties.
The benefits to you as the seller of the business include:
There are also disadvantages and risks associated with an earn out. Examples include:
An earn out may be very attractive to a buyer but can be less appealing to a seller, and disputes can often arise about the amount payable. These can be stressful and costly to resolve over a lengthy period.
Your solicitor will advise you on the negotiation of terms which are right for your circumstances and will ensure they are accurately reflected in the acquisition agreement. It is vitally important to seek expert legal advice on your specific circumstances at an early stage.
For further information, please contact the business team on 01782 525000 or email email@example.com.
This article is for general information only and does not constitute legal or professional advice. Please note that the law may have changed since this article was published