How to structure an earn out (and what to put in an LOI?)

by a searcher

1 year ago

I’m working on my first LOI. I’m wondering how an earnout structure works.  

The company’s performance in the last 3 years were not good. I spoke with the owners and they had some bad years due to unforeseen challenges that I deemed to be reasonable. But in the last year, the achieved $1m EBITDA. 

I’d like to derisk the transaction by having the owners stay on for 3 years (they seem amenable to the idea) to ensure that the revenue is stable. I’m thinking of pegging the milestones to 2% revenue growth and maintaining the same EBITDA margins.

What are the details that I’d put into the LOI? For instance, do the owners stay on as members of the company, or are they outside consultants?

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11 comments

searcher

I like percent of gross subject to a specific hurdle rate, how you price those will depend on the deal and its nature.

6 months ago | like reply | 0 likes

professional from Dartmouth College

Agree with others that they should generally be avoided if possible since they typically lead to disputes,, but if you need it best to limit to 12 months. Three years is a long time to have the current owners looking over your shoulder, unless they are rolling over equity. Gross is probably the simplest metric, but still has flaws.

1 year ago | like reply | 1 like

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