You might think that once the buyer and seller agree on the value of a company, the deal is done. In reality, that’s when the real work begins. The deal mechanisms and terms determine how, when, and under what circumstances the money is actually paid. In this blog, you’ll learn about these mechanisms and why they often make the difference between a good deal and a disappointment.
Earn-out: future payment
An earn-out means that a portion of the purchase price is paid at a later date, depending on the company’s performance after the acquisition. For the buyer, this reduces risk, because payment is made only if certain targets are met. For the seller, it can be an opportunity to generate additional proceeds, but it can also lead to disputes over exactly how results are measured.
Locked Box vs. Closing Accounts
The method used to determine the final price may vary. In a “locked box” arrangement, a historical balance sheet is used, and the seller guarantees that no value has been withdrawn since that date. In a “closing accounts” arrangement, the price is determined based on the actual balance sheet as of the transfer date. A “locked box” arrangement offers speed and certainty, while “closing accounts” provides greater precision.
Warranties and Disclaimers
A buyer wants assurance that the figures are accurate and that there are no hidden risks. That is why guarantees and indemnities are included in contracts. Examples include:
- Accuracy of Financial Statements and Contracts
- Absence of Hidden Debts or Claims
- Indemnification for specific risks, such as ongoing tax proceedings
It is important for sellers to limit the scope and duration of these warranties so as not to face risks years down the line.
Investments and Preferences
Private equity and venture capital deals often involve additional terms and conditions. A common provision is liquidation preference, under which investors are the first to recoup their investment in the event of an exit. You also sometimes see ratchets, which adjust equity ratios if results fall short of expectations. For entrepreneurs, these provisions can have a significant impact on the ultimate return.
Legal and Tax Requirements
Finally, legal and tax considerations also play a role. The structure of the transaction (transfer of shares or assets/liabilities), the tax treatment of the proceeds, and the liability periods directly affect the seller’s net proceeds.
Why All of This Matters
On paper, a deal may have the same value, but in practice, the seller’s proceeds can turn out very differently depending on the mechanisms chosen. Those who understand the details and negotiate effectively can often save a lot of money and reduce risks.
Frequently Asked Questions
What is the biggest risk associated with an earn-out?
That the targets are unclear or that the buyer can influence the results after the acquisition.
Which method is better: locked box or closing accounts?
The locked-box method provides certainty upfront, while closing accounts offers precision afterward. The choice depends on the situation.
Do I always have to agree to warranties?
Yes, they’re standard. But you can limit their scope, duration, and liability.
Negotiating the price is one thing, but the terms of the deal ultimately determine what you’ll actually walk away with. Want to know how to best protect your interests? The specialists at Hogenhouck M&A will guide you every step of the way, from pricing to the contract.
