It frequently happens that the seller and buyer disagree on the valuation of the company. The buyer is of the opinion that the seller has (too) rosy expectations about the expected financial results of the company in the future, while the seller feels that the buyer wrongly focuses on the uncertainties and risks.

In order to still be able to reach an agreement, an earn-out structure can offer a solution in such cases. In order to bridge the difference between buyer and seller, parties then agree that the buyer will still pay a (supplementary) part of the purchase price to the seller (the earn-out) when achieving previously agreed future uncertain events (the earn-out trigger) within a certain period after the transfer (the earn-out period).

While it may seem tempting to use an earn-out structure to get a deal done, in practice, working this out often turns out to be difficult.

Parties, and sellers in particular, are often insufficiently aware that buyers and sellers may have opposite positions when drafting and negotiating an earn-out arrangement.

After all, when working out an earn-out arrangement, both parties want to anticipate as much as possible the uncertain future events to be agreed upon. And therein lies the crux, because their interests with respect to those events do not always coincide.

Here are some examples from our experience as a business acquisition lawyer of topics on which buyer and seller may take opposite positions.

1. In the case of so-called "financial earn-out triggers," the question is which financial performance of the company parties want to match. From a seller's perspective, you would prefer to match an accounting standard as high as possible in the income statement. Specifically, in the case of a financial earn-out trigger, a seller wants to match a pre-agreed (minimum) turnover to be achieved. Because an increase in turnover does not necessarily equate to a higher profitability of the company, on the other hand, the buyer will often want to connect to profit.
   Connection to a profit concept again has the disadvantage for the seller that the buyer can exert more influence on the company's profit via "accounting tricks," such as accelerated depreciation. In this way, it is easier for a buyer to manipulate to get out from under an earn-out payment obligation.
   If the parties decide to earn-out, the parties will have to make clear agreements about the costs that may be charged to earnings and thus reduce profits.
2. The parties will need to make clear agreements on the accounting standards to be used to calculate financial performance.
3. Parties should consider for themselves whether they want to include a specific conflict resolution mechanism for the earn-out. For example, the parties can agree that any disputes will be referred to an expert in the matter, such as an auditor, instead of the usual court proceedings.
4. Often sellers do not sufficiently consider the consequences of an earn-out arrangement in case the purchased company is integrated into the buyer's group after the sale. What consequences does any synergy benefit resulting from the integration have for the earn-out arrangement?
5. With respect to business operations after transfer, the buyer will want to focus on the long term and maximizing earnings. From the buyer's perspective, this is understandable, but in doing so, the seller has not sufficiently ensured that the buyer also focuses on short-term business operations that should ensure that earn-out triggers occur as soon as possible.

In my experience, sellers often do not give enough thought to the above dilemmas when drafting acquisition contracts. While they are of great importance when acquiring a company.

Therefore, it is common for a conflict to arise between buyer and seller after the fact as to whether the buyer made sufficient efforts to comply with the earn-out agreements with the seller.

It follows from a recent ruling by the Amsterdam District Court* that a buyer does have a best-efforts obligation to the seller during the earn-out period, meaning that the buyer should take the seller's interests into account as much as possible in its business operations.

The premise is that the buyer should put the general business interest first in its operations, and within that framework, the buyer should consider the seller's interests in maximizing the earn-out. In other words, a company's general interest is co-colored by the seller's interest.

In practice, this means that a seller seeking to sue a buyer on the basis that the buyer is not making or has not made sufficient efforts to maintain earn-out triggers faces an uphill battle if the parties have not previously made concrete agreements on the course of action to be taken by the buyer with the acquired company.

It is therefore recommended that, prior to entering into the purchase agreement, a seller carefully identify the expectations he anticipates that the earn-out triggers will be achieved and the steps he believes are necessary to achieve the realization of that expectation, so that the parties can then agree in the purchase agreement on the conditions for payment that are as concrete as possible.

Advice for you

If you have any questions, call Ernest Loor at 06-54 361 438

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* Rb Amsterdam dated November 19, 2019, ECLI:NL:RBAMS:2019:8689