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What is an earn-out and how do they work with a MBO?

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What is a MBO?

MBO stands for ‘Management Buy Out’ and is a type of business acquisition which involves the existing management team of the selling business move into the company which has acquired them. This type of arrangement has many benefits. The main advantage is that by keeping the management team in place, the transition over to the new owners is typically much smoother and is done with the minimum amount of disruption possible.

As with most acquisitions, however, there are often some hiccups during the negotiation process. Unsurprisingly, a disagreement between the two parties regarding the valuation of the business is among the most common hurdles to be overcome. In order to stop the sale grinding to a halt, the deal may instead be structured to include what is known as an ‘earn-out’.

What is an earn-out?

Earn-outs are often the compromise reached when the vendor and purchaser cannot agree on a valuation for the business being bought. An earn-out bridges the gap between the two valuations and requires the sellers to ‘earn’ an additional amount of money based on the future performance of the business. The seller will only receive this additional portion of money if the business performs at a level agreed to during the acquisition negotiations. An earn-out essentially lets the seller justify the larger valuation that they place on the business, by demonstrating its potential for success and profitability going forwards.

So long as it is structured correctly, an earn-out can be a beneficial agreement for both parties; the seller is able to prove the value of their business and achieve additional compensation in the process, while the buyer eliminates some of the risk associated with the purchase should the company fail to perform after the transaction. An earn-out gives the seller an added incentive to ensure the success of the business going forwards. Should the business not perform as the buyer expected then they have been given some protection against overpaying.

Earn-outs can also be used as a way of overcoming funding issues. By deferring a portion of the consideration to a later date, means that the buyer has to find less money up front in order to facilitate the purchase. In some instances, being able to delay some of the payment is the only way in which the deal can be completed at all.

How can we help?

A deal which involves an earn-out component needs to be carefully structured to ensure it is fair on both parties, achieves the desired result, and aids the completion of the transaction. With over four decades of experience, the experts at Selling My Business are perfectly placed to answer any questions you may have about disposing or acquiring a business, as well as providing you with guidance as to how best to fund or structure a sale or purchase. We can assist you every step of the way, from initial discussions, through the often complex due diligence procedure, and ending with a successful completion. Contact our specialists today to see how we can help.

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