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“Earn Outs” "Earn Outs"In business sales an earnout is "an arrangement in which the seller of a business receives future payments based on future profitability, earnings or other certain financial benchmarks." This arrangement is not uncommon with the sale of accountancy practices, property management portfolios, and financial advisory businesses. These are all businesses where there is a low tangible asset content and the value of the enterprise lies in the retention of the client base and the income stream flowing from those clients. The nature of the earnout will vary according to the sector - e.g. it may be six months for a rent roll but 13 months for an insurance brokerage reliant on annual renewals. Sometimes we get other business buyers trying to negotiate a deal where a percentage of the price is paid on settlement with the balance contingent upon certain revenue or profit targets being achieved. As agents for the seller we rarely endorse these approaches. While they may be a great comfort to the purchaser, they may be a great risk to the seller. If an earn out is contemplated the agreement needs to clearly state the benchmark it is based upon, what financial reports will be supplied, and what access the seller will have to the purchaser's records. Yeah... right! We recently received notice of the launch of an online Business Capitalisation Rate Calculator with which "accountants and lawyers will be able to accurately value businesses for relationship breakdowns, business disputes, ownership changes, succession and planning." This week's newsletter from the Institute of Business Appraisers, coincidentally, made the following comment: "The Institute of Business Appraisers is frequently asked to endorse appraisal software, and declines to do so. Software has it's place in business appraisal (imagine always running by hand the calculations you can program into Excel!) but it is no substitute for professional judgement and the wordsmithing of the qualified appraiser. And, as you have probably experienced, one size doesn't fit all." We agree. Computers are an invaluable tool but all valuations are opinions and, inevitably, involve many subjective judgements which must be very difficult to build into any software program. We will watch with interest. |
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