Commercial: Deferred Consideration and Earn-Outs

Deferred Consideration and Earn-Outs explained

When selling a business, it is not unusual for part of the purchase price to be paid after completion. You may be offered a deal where a percentage of the price is payable over a number of years or months (deferred consideration) or payment may be conditional on the performance of the business (earn-out consideration).

When sellers find themselves in this situation there are several considerations, some of which are outlined below.

Security

If the purchase price is to be paid over time then you may require the buyer to provide security for that payment. This could be through charges over the target company, the buyer or personal guarantees.

The buyer’s ability to give this security will be impacted by how the buyer is financing the sale or any incumbent lending. We can advise on your options and prepare deeds regulating the relationship between the lenders/charge holders.

This is something which should be considered at an early stage. It may be very difficult to re-negotiate whether security is on the table once you have agreed the terms for the sale.

Acceleration

You should consider requiring the payment terms for the deferred consideration to be accelerated should certain events occur. For example, should the buyer look to sell the business in the future then you may want to be paid up first.

Service As Employee

The payment may be contingent on you remaining with the business as an employee for an agreed period after the sale. If you don’t complete that agreed period then payment may be affected by whether you are considered a “good leaver” or “bad leaver”.

The exact meaning of these terms will be defined in the sale agreement. We can advise on these and ensure you understand them. However, by way of example, a good leaver may be if you were to resign for ill health; while a bad leaver may be if you were to be dismissed for gross misconduct.

Control Over The Business

If you are remaining with the business after completion, it should be taken into account that working as employee is very different from working as owner-manager. You possibly may have very little control over the business after the sale (with the exception of any consent matters, discussed below). You would need to be comfortable with this change in circumstances.

You should make sure you are happy with your terms and duration of employment, as there could be consequences should you want to leave early (see above).

Earn-Out Conditions

Payment under an earn-out is usually not guaranteed and depends on some form of commercial target being achieved. It may be that minimum and/or maximum thresholds are placed on the payment terms. You should ensure you have a clear understanding of what the target is, how it is calculated and whether you consider this is achievable.

Drafting earn-outs can be complicated and technical. We can advise on them and ensure they are drafted fairly and correctly.

Consent Matters

If the purchase price is not fully paid upfront, you should consider provisions in the agreement relating to how the business is to be ran during the interim period. This is particularly the case with an earn-out consideration. If the buyer makes material changes to the business without your consent then this may impact on you being able to meet the criteria for you to be paid.

 

How We Can Help

At Lawson West, we understand that selling your business is a major decision and the result of many years of hard work. The process is much easier when you have an experienced partner advising you and helping you overcome obstacles along the way.

Our approach is to provide comprehensive support and guidance throughout the transaction. We look to make sure that any sale agreement is fair, proportionate and suitable to the deal you have negotiated. We work with you and your other advisers so that you can confidently proceed with your business sale and look to achieve a successful outcome.

If you believe you have a situation where you require legal advice, please contact us on telephone 0116 212 1000 or 01858 445 480, alternatively complete the free Contact Us form and we will get in touch as soon as possible.

You can Contact Us in the strictest confidence, ask for Rob Flannagan or Louis Tranter:

Rob Flannagan	Louis Tranter

    

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