Since the beginning of the Corona crisis, we have recently seen a recovery of the market for company acquisitions and sales (M&A), especially in the segment of medium-sized M&A transactions.
The biggest challenge in M&A transactions in times of Corona is the agreement of a purchase price, since reliable planning as a basis for a company valuation is often associated with greatly increased uncertainties,
The interests of the parties involved in determining the purchase price are normally relatively easy to define: the seller is convinced of his company and that it will continue to prosper in the future, and will therefore want to realize a purchase price that is as high as possible and appropriate from his point of view. The buyer, on the other hand, will enter into negotiations rather conservatively, as he will regularly assume or even have to assume certain risks and imponderables.
In contrast to the normal case, in which the economic risk associated with the company is fully transferred to the buyer upon conclusion of the contract or on a certain date, the amount of the (final) purchase price will (at least partially) depend on the future financial development of the target company if the parties agree on an earn-out clause.
With an earn-out clause, the seller thus bears at least part of the risk of the planned development of the company and can thus signal concessions to the buyer. Furthermore, such a clause may also offer the seller the opportunity to continue to participate in an unexpectedly positive development of the Company in the future.
Options for Earn-Outs
Background to any earn-out consideration is the circumstances under which a flexible purchase price is paid.
The prevention of abusive behaviour – i.e. behaviour that influences the earn-out to the detriment of the other party – regularly causes particular difficulties.
The purchase agreement should therefore contain provisions to protect against abusive measures (e.g. no change in the accounting methods applied to date, review of the earn-out calculation and its basis by the seller if the seller no longer has any control over the company at the time of the earn-out calculation) that abusive measures are not taken into account for the determination of the earn-out or the earn-out criteria. These provisions will often remain abstract (as it is hardly possible to list such constellations conclusively), but in the event of a dispute they do at least provide a contractual starting point for the party concerned to defend itself if the other party subsequently attempts to influence the earn-out unilaterally.
Further attention to the following is also required:
- earn-out term (typically between 1-2 and 3-4 years);
- earn-out ratio, i.e. a maximum flexible purchase price amount, which, measured against the total purchase price, is often in the range of 20-30 %;
- payment terms and safeguards, which regulate whether and when which payments are due and – important from the seller’s point of view – whether any additional purchase price claims are secured, e.g. by a parent company guarantee or payment of a partial amount into an escrow account or the provision of a bank guarantee; and
- conflict resolution mechanisms with regard to the determination of the earn-out purchase price.
Implications of Corona Pandemic on M&A Transactions
Due diligence, i.e. the examination, analysis and evaluation of the financial figures and the legal and tax circumstances (in addition to e.g. operational due diligence) of the target company has gained considerably in importance in times of increased uncertainty.
From an economic point of view, the buyer takes a very close look at the consequences of the corona pandemic for the target company and its sales and short and medium-term forecasts. Relevant factors are, for example, whether the target company can maintain its operations, whether the supply chains are sufficiently secure or the impact of the corona pandemic on demand.
Due diligence and the particular effects of the Corona pandemic can lead to the deal being burst or the purchase price being adjusted to the current situation.
If the prognosis for the economic development of the target company has deteriorated massively or if the buyer gets into economic difficulties, the buyer will refrain from concluding the contract or at least the contracting parties will put the transaction on hold for the time being. A further reason for the buyer to abstain may also be that in this situation the buyer will not receive (external) financing for the acquisition of the target company.
If both parties wish to continue with the intended transaction, the initially announced purchase price for the target company is nevertheless often subjected to a critical review. In many cases, the buyer will negotiate a reduction of the purchase price.
Gerade in der aktuellen Situation können Earn Out-Klauseln ein geeignetes Instrument sein, unterschiedliche Ansichten zum Kaufpreis zu überbrücken. Wesentliche Bestandteile werden auch jetzt häufig der Umsatz und/oder das EBIT/EBITDA sein.
Bei der Laufzeit des Earn-Out sollten hingegen Auswirkungen der Corona-Pandemie berücksichtigt werden. Es kann u. U. Sinn machen, die Laufzeit des Earn-Out zu verlängern oder dessen Zeitraum erst im Jahr 2021 beginnen zu lassen.
Earn-out Clauses as a potential solution to address uncertainty
Depending on the strength of his negotiating position, the buyer in particular could also press for the granting of a so-called MAC clause (Material Adverse Change). Such a clause offers the buyer the opportunity to withdraw from the contract before the transaction is completed if the effects of the crisis reach a level that can be specified in more detail. From the buyer’s point of view, this is particularly appropriate if it is not yet foreseeable at the current time how the company will develop or what effects the pandemic will ultimately have on the target company. Often, however, the seller will not want to get involved in this – it therefore depends, as mentioned above, on the strength of the buyer’s negotiating position.
Summary and outlook
In times of increasing uncertainty, earn-out clauses offer the opportunity to conduct M&A transactions with a balanced risk/reward distribution on the buyer and seller side. The biggest challenge in the implementation of earn-out clauses is that they are designed in such a way that the possibility of abuse is reduced to a minimum.
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