Michael Pilegaard Hansen, assistant attorney
Mph@edisonlaw.dk | Linkedin
Earn-out for founders is a term which can be put into action if you are considering selling your company.
Earn-out covers a set of different terms.
They all work as conditions for you to receive the full purchase price.
Earn-out for founders can be of extreme importance.
The joy of selling can easily be destroyed from three years of moving back and forward in a huge organization working for people who don’t care about you.
In this blog post I will describe the main issues that you should know about earn-out.
#1: Understand acquirer’s context
There is a good chance that buyer will be a large corporation.
If that is the case, you shouldn’t count on anyone having a plan for you as an individual person. Or your co-founders. Or your team.
The decision to acquire your start-up is often taken by a high ranking person within acquirer’s company.
This person has told the M&A department to get the deal done.
There is often a disconnect between the M&A department, the upper strategic management and the department where you are going to work.
Perhaps they have not really been told what to use your start-up for.
Additionally, there can be a poor internal connection between acquirer’s different departments.
Therefore, you should take responsibility of the negotiations.
Don’t assume there will be a plan for you or your team.
Or a plan at all.
#2: Typical elements in earn-out
Typical elements in an earn-out clause can include:
- Founders shall stay and work for acquirer in a period after the acquisition, e.g. one to three years
- The final purchase price is dependent on a certain revenue after the acquisition
- The final purchase price is dependent on a certain profit after the acquisition
- The final purchase price is dependent on growth or performance on other parametres after the acquisition, e.g. related to user behaviour or product development
The deal will typically be a combination of up-front payment and additional payment which is dependent on the terms of the earn-out.
How is the split between those two?
It’s up for negotiation.
The up-front payment will typically amount to 60-80% while the remaining 20-40% is reserved to the earn-out.
Particularly, founders’ risk appetite and will to stay are elements that can change that distribution.
If you are willing to bet on future growth you will have a better opportunity of negotiating a larger potential purchase price.
#3: Negotiate your role early
Most acquirer’s are clever.
They will postpone the negotiation regarding your future role to the very last.
At this point you are so invested in the process that you will say yes to anything. Many founders will regret this.
But your role is extremely important. Important for your mental well-being in the next few years.
To important to postpone to the very last.
If you, like many other founders, appreciate creative freedom, exciting challenges and the opportunity to create great results.
You should negotiate your own role as soon as possible.
#4: Make demands on your role
There is a good chance that the department where you are going to work didn’t had anything to do with the acquisition.
Ergo: They are much less excited about the acquisition of your start-up than you are.
Therefore, it is important to make demands on your role.
And your team’s role.
The demands should be included in the judicial terms of the acquisition.
It is not enough just to have talked about it.
The demands could be:
- That you should operate as an independent company, potentially, as a subsidiary company to the acquirer.
- What you and your co-founders’ tasks should be.
- That you won’t be assigned different tasks against your will.
- Specific conditions of employment, such as salary, equity and benefits.
- That you and your team should remain one unit internally after the acquisition.
#5: Who is in control?
Ask yourself who is in control if you e.g. are negotiating earn-out based on revenue or surplus.
Is it one of acquirer’s people?
If so, this person will be able to impact whether or not you will achieve the goals that have been set for the earn-out.
Acquirer can influence the revenue by investing. This can affect the revenue significantly.
Acquirer can decide to invest less in sale and product development in order to possibly lower the surplus.
Leaver scenarios are also important.
Basically, acquirer should not be able to fire you and thereby preclude you from the earn-out payment.
Michael Pilegaard Hansen, assistant attorney