Record deal values. Surging M&A volume. And a rising use of contingent payment clauses in merger agreements? The discordant note in an otherwise harmonious dealmaking aria is an apparent contradiction that Grant Thornton’s national managing principal for M&A Elliot Findlay puts down to persistent side effects of the pandemic. Let’s examine why 42 percent of surveyed dealmakers see a “significant increase” in earnout-related disputes and the deflationary implications of increasingly contested merger payouts.
“I’m working with investment banks helping preparing companies for sale by writing a quality of earnings report,” Findlay explains. “Twelve months ago, I was talking about normalizing for Covid; now I’m writing about normalizing for supply chain disruption or workforce shortages.”
While the catalysts may be shifting, the clauses are still a mainstay. And they’re rife for buyer-seller conflict. Say a private equity buyer acquires a carve-out that then “sells” its services to an existing customer of the new parent platform. The target can argue these sales counts towards an earnout. Revenue is revenue. But to the acquirer, the client relationship was already built in-house, so cross-selling doesn’t tally toward the earnout.
“Unless they’re clearly defined, there’s always problems with earnouts,” Findlay says, noting the ongoing M&A boom could mean this is only the beginning. “There’s probably more to come—sometimes there’s a one, two, or even three-year judgment point.”
That has implications for deal values going forward, though for once, the news might be good for those chasing increasingly expensive targets. Contingent payments could put about 10 percent of a deal’s value in play (a figure that hit 39 percent in 2020), constituting a discount for buyers with sufficiently shrewd legal drafters.