What is an Earnout Agreement Review?
An earnout agreement is a legal contract between a buyer and seller. It’s commonly used during a company merger or acquisition. When a business gets sold, the seller receives some of the purchase price immediately and the rest of the money when the company reaches certain milestones.
Reviewing an earnout agreement is important to do before agreeing to its terms so that it’s accurate and doesn’t put you at hidden risk.
In this article, we’ll explore some common terms to review in an earnout agreement, how to review it for accuracy, and how a qualified lawyer can assist you with the process to protect your interests.
What Key Terms are in an Earnout Agreement?
An earnout agreement usually contains the following key terms, which you should review for clarity.
- Earnout period. Check that it’s specified when the company’s performance will be measured before funds are required.
- Formula. Another piece of information to check is the payout formula, since it explains what the seller receives based on performance metrics.
- Payments. All payment terms must accurately reflect the deal. Check that the agreement states how payments will be made, such as via equity or cash.
- Performance metrics. You want the goals or milestones that trigger payouts to be clearly defined.
- Earn-out cap. To limit the buyer’s responsibility and protect their interests, ensure that the total earnout amount provided to the seller is capped.
- Operating covenants. These rules must be clear and specific as the buyer will follow them when managing the business and it enables the specified goals to be reached.
- Change of control. If the buyer sells the business before the end of the earnout period, this clause makes it clear that any remaining amounts will become payable.
How Do You Review an Earnout Agreement?
When reviewing an earnout agreement, there are specific things to look for so that you avoid disputes between parties or other challenges.
Be Clear About Buyer Restrictions
The earnout agreement might prevent the buyer from conducting certain activities, such as moving revenue to another company, changing the pricing, or moving customers. Ensure these are clearly stated so that you don’t have any uncertainty.
Check the Earnout Period
Don’t gloss over the earnout period in your agreement. It has to have a fair and reasonable duration to prevent issues. For example, it shouldn’t be too long as this could delay payments. Usually, earnout periods last for one to three years.
Look for Operating Covenants
The seller needs to have clarity about how the business will be managed during the earnout period. Check that the agreement contains operating covenants that are clear and specific. Avoid ambiguous language that can be misinterpreted.
Consider Partial Payouts
It’s worth discussing partial payouts during negotiations with the other party. Having clauses in the agreement that enable partial payments to apply if some targets are met can protect your interests and prevent you from being empty handed, which is what could happen if the agreement states that you’ll receive nothing if no targets are met.
Scrutinize After-Sale Controls
You want to ensure the agreement deals with what happens after the business is purchased, such as who will handle budgeting and accounting responsibilities.
Should You Hire a Lawyer to Review an Earnout Agreement?
It’s a good idea to hire a qualified lawyer to review your earnout agreement for you to prevent challenges or risks. A lawyer has the skills to help you by:
- Ensuring the earnout is clearly defined. They’ll make all terms in the agreement clear to minimize the risk of misunderstandings.
- Setting fair and measurable performance targets.
- Protecting both parties’ interests by considering future challenges and inputting provisions to protect their finances.
- Reviewing the tax treatment for earnout payments.
- Customizing the agreement to your specific transaction and business goals.
- Complying with all laws and requirements to make provisions in the agreement legally valid.
- Making revisions to your earnout agreement if required so that any ambiguous wording is clear and specific.
Where to Find and Hire a Lawyer for an Earnout Agreement Review
If you’re worried that finding a reputable lawyer to review your earnout agreement is going to be stressful, using an online legal platform makes it a convenient, stress-free experience. On online legal platforms, you can access a network of qualified lawyers who are experienced to help you.
ContractsCounsel, one of the largest online legal marketplaces, enables you to connect with a curated network of vetted lawyers. All lawyers on the platform have years of experience in contract drafting and review.
To request that a lawyer on ContractsCounsel reviews your earnout agreement, here are the easy steps to follow:
- Go to the ContractsCounsel marketplace.
- Post your project for free. Include a few details to help you find the most suitable lawyer, such as why you want the agreement reviewed.
- Wait for bids. Receive multiple bids from lawyers directly on the platform, without having to reach out to them. You won’t only receive one bid, which gives you a greater selection of lawyers from which to hire one.
- Review the lawyers’ profiles. The platform provides lots of lawyer data, such as their location, client ratings for previous projects, expertise, and credentials. This makes it easier for you to research the lawyers and choose one that matches your requirements.
- Connect with a lawyer you think is best suited for the job and hire them to review your earnout agreement for a flat fee.
