What is Earnout Agreement Drafting?
An earnout agreement is a contract used in a company merger or acquisition, between a buyer and seller. How it works is that when a business is sold, the seller gets a part of the purchase price upfront and the rest when the business reaches certain milestones.
If you need to draft an earnout agreement, read the rest of this article to explore what key terms it should contain, how to draft it for accuracy, and why you should consider hiring a qualified lawyer to ensure a professional earnout agreement drafting process.
What Core Components are in an Earnout Agreement?
An earnout agreement typically contains key terms such as the following:
- Earn-out period. This specifies the time when the company’s performance is measured prior to the funds being required.
- Performance metrics. This details what performance goals or milestones must be met to trigger payouts.
- Formula. The payout formula must be clarified to determine how much the seller will receive based on those performance metrics outlined in the agreement.
- Earn-out cap. To limit the buyer’s liability, there should be a limit placed on the total earnout amount that will be given to the seller.
- Dispute resolution. If parties disagree, the earnout agreement should specify how they can resolve their conflict, such as by hiring an independent accountant to check their calculations.
- Operating covenants. This refers to how the buyer must follow certain rules when managing the acquired business. This makes it possible for the seller to reach the specific milestones outlined in the agreement.
What are Tips for Drafting an Earnout Agreement?
An earnout agreement needs to be clear and specific to prevent disputes between parties. Here are some tips for drafting it.
Clarify Metrics
You should clearly define performance metrics determining if the earnout is achieved. Although financial measures such as revenue are common, you might want to consider non-financial metrics, such as customer retention or subscriber growth.
Consider Control Limits
It’s common for sellers to be concerned about how they will meet their earnout targets. To assist the seller during the drafting process, you might want to include operating covenants describing how the business will be managed during the earnout period.
This protects the seller by ensuring the buyer doesn’t conduct activity that unfairly decreases the seller’s chance to achieve the earnout.
Establish Deadlines
Reporting earnout results must be done carefully and within specific deadlines. This prevents ambiguity that can cause disputes.
To settle disputes should they arise, the agreement must have a solid dispute-resolution process in place, such as referring accounting disputes to an independent accounting expert. This can help you to avoid time-consuming and expensive litigation.
Detail Payments
One of the most important aspects of your earnout agreement is how payments will be conducted. Provide details about how and when payments will be made after performance targets are reached.
It’s important to specify potential tax treatments involved, as this could depend on the specific transaction structure and relevant tax laws.
Set an Earnout Period
To prevent disputes, your earnout period, or the period in which performance targets must be reached, should be fair to both parties. If it’s too short, this might make it too vulnerable to economic changes. On the other hand, if it’s too long, this could increase uncertainty or delay payments. It’s common for the earnout period to be between one and three years.
Do You Need a Lawyer for Earnout Agreement Drafting?
It’s worth consulting a lawyer to draft your earnout agreement for you, as this will help you to avoid making costly mistakes or putting yourself at legal risk. A lawyer will assist you in various ways, such as by:
- Defining the earnout. They will ensure that the terms are clear and precise so that there aren’t misunderstandings.
- Creating measurable performance targets that are realistic and enforceable.
- Protecting your interests, whether you’re a buyer or seller. They’ll identify any potential challenges so that they can include provisions in the earnout agreement to protect your future finances.
- Addressing any legal or commercial issues, such as tax implications and post-sale duties.
- Reducing the risk of expensive and time-consuming disputes. They’re skilled at identifying any potential areas of disagreement so you can prevent conflict.
- Customizing the agreement to your specific transaction. A lawyer will ensure that the earnout agreement reflects your specific deal, industry, and commercial goals.
- Complying with all laws and requirements. This keeps all earnout provisions legally valid and enforceable.
- Reviewing the earnout agreement if you’ve already drafted it so that it’s clear and specific.
Where to Find a Lawyer for Earnout Agreement Drafting
If you’d like to hire a qualified lawyer to draft a clear and polished earnout agreement, you don’t have to worry about where to find one. Online legal platforms make it easy to connect with a reliable, experienced lawyer.
ContractsCounsel is one of the largest online legal marketplaces that gives you access to a curated network of vetted lawyers. Since all the lawyers on the platform have years of experience in contract drafting and review, requesting that one of them helps you with the process is easy.
Here are the steps to follow online:
- Visit the ContractsCounsel marketplace.
- Post your project for free. Include a few details to help you find the most suitable lawyer.
- Wait for lawyer bids. You’ll receive multiple bids from lawyers on the platform who want to work with you.
- Review the lawyers’ profiles. ContractsCounsel provides extensive lawyer data to help you choose the right lawyer, such as their location, client ratings for previous projects, expertise, years and experience, and credentials.
- Connect with a lawyer you think is best suited to your requirements and hire them to draft your earnout agreement for a flat fee.
