When Does an Earn out Agreement Make Sense? Part 2
Newsflash: If something is too good to be true, it usually is. This particularly applies to using an earn out agreement as a market development strategy.
Sorry to break the news to you, but regardless of whether you’re a printing owner or you’re investing in a printing business, an earn out can be a very tricky arrangement. In part 1 of this series, I discussed some of the pros and cons of an earn out for both the buyer and the seller.
Now I’d like to look at why an earn out is so hard to pull off, and generally works worse for the seller. Here are a few reasons:
1.
There’s too much fudge factor on each side of the equation. A buyer sets a number of pre-determined goals for the earn out. If the seller gets close to those goals, it’s possible the seller could sabotage some sales in order to avoid payment.
Likewise, the seller may try and distort the earnings in order to meet goals, or they could make short-term decisions instead of thinking about the best long-term options for the company.
2.
It’s difficult to define roles. Structure, metrics, and clear lines of responsibility are critical for an earn out to work. Unfortunately, that’s easier said than done. It may seem like an ideal situation to have the buyer take a hands-off approach and let the seller do what they do best, but how hands-off will any investor be if their $100 million investment starts tanking?
You can structure parameters such as minimums for marketing expenditures, or agreements in which you agree to a certain business model, but these can be very subjective parameters. Again, there’s a lot of room for interpretation – and misinterpretation.
3.
You’ll likely need lawyers, guns and money. A deal like that is going to be complicated – bank on it. And chances are very good that you’re getting into a situation where your investor will show you a new, and potentially very unattractive side to their personality.
What I’m getting at here is that if you’re the seller, you’re going to be entering a complicated deal in which you could stand to lose your business, go through hell in the process, and not have a leg to stand on. Your investor likely has deeper pockets than you, so if things go bad, you’ll be cutting losses. Big-time. That means lawyers, money, and hopefully not guns.
So what should you do to make an earn out work for you? In the next post, I’ll give you some tips.
(Photo by USACEpublicaffairs)
To read about mistakes to avoid when selling your printing business, download, Rock LaManna’s “12 Code Red Seller Mistakes.”
Rock LaManna provides executive coaching for printing owners looking to grow their printing business, merge with a synergistic partner, make a strategic acquisition, or create a succession plan.