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What is an 'Earn Out' and when is it appropriate?

 

An earn out agreement is the sale of a business involving part of the sale price being determined by the performance of the business over an agreed post-sale trading period.

A sale involving an earn out will typically involve an initial payment on completion of the deal, followed by further deferred payments over a number of years.
The earn out payments are normally calculated and paid as a percentage of annual turnover or profits.


How does it work?

A typical earn out deal for an optical practice might look something like this:
The purchaser pays £150,000 on the date of completion
The purchaser pays a second sum based on 10% of annual sales in their first 12 months of ownership
The purchaser to pay a third sum based on 10% of annual sales in the 2nd year of trading

Turnover is the most common measure of performance, due to the simplicity of measurement.
Measuring profits can be significantly more complex and expensive to encapsulate within a contract and to police in practice. Without relevant protection, profit can be suppressed or manipulated by the buyer to reduce the amount they pay.

Legal and professional bills for earn outs based on profits tend to be significantly higher for both buyer and seller. The parties have to agree on a detailed, prescriptive framework of how the accounts must be structured during the earn out period, in terms of what constitutes a fair expense or drawing. Whilst much rarer, there are specific circumstances where it is appropriate for an earn out to be based on profits but this is unusual in the optical sector.

In summary, the key variables are:
•    The sum paid on the date of completion
•    The measure against which the earn out is to be measured (i.e. annual turnover or profit)
•    The percentage of annual turnover or profits the extra payment will be made against
•    The threshold (if any) over which the percentage will be paid
•    The number of years the earn out will run for (typically between 1 and 3)
 

How common are earn outs in the optical market?

Our very extensive experience  shows that sales involving an earn out arrangement are currently the exception rather than the rule in the optical market.

Why use an earn out?

Most practice sales are conducted based on a fixed agreed fee, based on historic performance. An earn out is most likely in the following circumstances:


Need to know more?

If you are a practice owner who has been approached by an intestered party and offered an earn out deal for your business, make sure you keep your best options open by calling Dominic Watson on 0161 929 8389 for impartial, independent and confidential advice. 
 
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