As mentioned earlier, buyers and sellers usually have different views on valuation during a negotiation. This is not a cause for concern as long as their views fall within the Possible Area of Agreement (ZOPA). However, as mentioned earlier, there are circumstances in which the degree of uncertainty about the target company`s future cash flows is so high that the views of both parties are outside zopa. These circumstances usually fall into one or more of the following categories: the seller may set a minimum earning percentage for each year or a minimum amount. In the first year, the minimum may be 10% of net earnings before interest, taxes, depreciation and amortization (EBITDA) and at least $150,000. In the second year, the minimum could be $200,000 and so on. Basically, the better the company`s performance, the faster the seller-financed loan is repaid. The principles of an earn-out are similar to seller financing in real estate. Often, buyers and sellers agree on the price; However, buyers perceive exogenous risks that could lower the performance of the target company and try to structure earnouts to transfer the risk of underperformance to the seller. The most typical exogenous risks I`ve seen in my practice are recession fears and client concentration. However, as with most acquisitions, there are often a few hiccups during the negotiation process.
Not surprisingly, a disagreement between the two parties over the valuation of the business is one of the most common hurdles to overcome. To prevent sales from stopping, the deal can instead be structured to include what`s called an earn-out. In the situation I am asking myself, the earnout would be considered as compensation. My problem is this: can the earnout be paid to the selling company «S», provided that the benchmarks are respected? Can the owner of «S» Corp also be an employee and, as a pure employee, earn compensation that is not related to achieving benchmarks? Earnout agreements are legal and binding contracts that legally govern and detail the structure of an earnout. .