Market Standards: Trends in Earn-Out Covenants

Despite intensive due diligence and financial analysis, many buyers may remain concerned about financial performance and profitability of a target company post-closing. Earn-out payments can help buyers balance concerns of overpaying for the target with a seller’s concern that the business is being undervalued, though, such provisions can be subject to extensive negotiation. Few parts of an earn-out mechanics are negotiated as extensively as post-closing covenants, and for good reason. Although a target’s financial success post-closing benefits both buyers and sellers, sellers will seek to set limits on buyer’s operation and support of the business during the measurement period, while buyers will want to reserve their right to run the business as they see fit.

Reflective perhaps of broader market forces, earn-out covenants were used infrequently last year. According to Market Standards, just 35 transaction agreements were filed between December 1, 2021 and January 1, 2023 that imposed explicit conditions on the buyer’s operation of the target post-closing, compared with a total of 1,375 transaction agreements that imposed no conditions or requirements on buyer whatsoever. Of those 35 agreements:

• 9% (8) required the buyer to at least maintain separate books and records of account for the business
• 6% (3) required the buyer to operate the business post-closing in a manner consistent with past practice
• 7% (2) called for the buyer to provide reasonable financial support to the business post-closing
• 7% (2) agreements required the buyer to maximize the earn-out for the Seller

Notwithstanding those covenants, a full 91% (32) of the filed transaction agreements that addressed a post-closing earn-out covenant still reserved buyer’s right to operate the business in its reasonable, good faith, or absolute discretion, regardless of the appearance of other covenants.

Market Standards is a powerful tool for researching and comparing over 38,000 M&A transactions from 2008 to the present. Leverage Market Standards to find on-point precedent language on the most highly-negotiated transactions with over 150+ M&A deal points. To learn more about how it can help M&A attorneys work more efficiently, click here.

Discover Emerging Trends in M&A Transactions

Learn more about drafting and negotiating earn-out covenants and provisions in this practice note.

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Related Content

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• Earn-Out Provisions Key Considerations Chart
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• Market Trends 2021/22: Earn-Outs in Public-Private Deals
  See the bigger picture with this analysis of market trends in public-private deal earn-outs.

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