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Why earn-outs don’t work out for sellers

On Behalf of | Aug 25, 2016 | Buying & Selling Businesses |

In an effort to get the highest price while selling their business, North Carolina owners may be tempted to accept an earn-out. An earn-out is a deal where a business is acquired for a cash amount plus more money if the newly-acquired company reaches financial goals in a certain period of time.

While an earn-out may sound good to people who are struggling to sell their business, this type of arrangement is usually much better for the buyer than it is for the seller. That is because the money that is promised for goals reached in an earn-out hardly ever materializes. A newly-acquired company that agrees to an earn-out usually does not reach its financial goals, and the earn-out money can be highly illusory.

One example of an earn-out that did not pan out was the acquisition of AfterMail by Quest. Quest agreed to pay $15 million for AfterMail plus another $30 million if AfterMail could hit specific financial goals after becoming a division of Quest. The founder of AfterMail was optimistic about hitting the earn-out goals but soon realized that the goals were unattainable. While adjusting to the Quest culture, the AfterMail founder fell far below his targets. He decided to give up on the earn-out and leave Quest after nine months.

One of the reasons earn-outs often don’t work well for buying and selling businesses is that the buyer has no interest in helping the newly acquired company reach its earn-out goals. An attorney may be able to help a company to negotiate an acquisition agreement that the client can be happy with.