ERSM110900 - Securities Options

Earn-outs: what are they?

An 'earn-out' will often occur when a business is sold and there is difficulty in agreeing a value fair to both vendor and purchaser. In such circumstances, an earn-out represents further consideration for the purchase of the business. Typically, the vendor will receive a cash sum, or an initial issue of securities, plus an "earn-out" consisting of:

• a right to receive loan notes (issued by the purchaser) after a certain period has elapsed and dependent on the performance of the newly taken-over business. The loan notes would be redeemable after a certain period or periods, or
• a right to receive securities in the purchaser or its parent company after a certain period has elapsed and dependent on the performance of the newly taken-over business. These may or may not have restrictions placed on them.

Earn-outs could also be constructed using:

• restricted (forfeitable) securities (shares or loan notes) issued by the purchaser and which vest after certain performance targets have been reached, or
• convertible securities, issued by the purchaser and which convert into a more valuable security after certain performance targets have been reached.