Earn-outs and Coronavirus – what happens if the terms of your earn-out can no longer be achieved?

13 May 2020

What may have seemed a reasonable target or trigger pre lock down may no longer be possible to achieve in circumstances which very few could have foreseen just a few months ago.
Sellers may have protected their earn-out with drafting in the sale documentation, including adjustments if business does not perform as expected; this may have included buyer commitments about how they will operate post completion and  covenants to protect future performance. The balance will be down to negotiating strength but often sellers, keen to ensure their transactions are closed, will take greater risks on the earn-outs. This is particularly the case as sellers will usually have substantive continuing involvement in the business going forwards comforted by the fact that they will have a good say in influencing their own destiny.
So, what if an element of the business on which your earn-out is dependent is no longer viable as a result of Coronavirus and a buyer has taken the decision to reduce trading or to shut it down completely? Where does that leave the parties and what are the options?
In the first instance, sellers should check the drafting of their sale agreement and earn-out provisions carefully, it may be that there are specific protections which were incorporated that will assist.
Sellers may also want to consider approaching the buyer to vary earn-out terms.  This might not be as impossible as it sounds, especially if buyers need the sellers to help the business perform. This could include, for example, removing certain revenue streams, amending triggers, adjusting the amount of earn-out consideration or extending the timeframe over which the earn-out can be achieved.
Whilst making amendments to an agreement after a transaction has completed can be challenging, the current circumstances are so exceptional that both parties may consider it in their mutual interests to go back to the table to look to vary the terms of an earn-out. The benefits from the sellers’ perspective will be obvious in circumstances where there is likely to be a detrimental impact on their earn-out value. From a buyer’s perspective, the buyer would be keen to ensure that the sellers remain motivated to achieve performance targets which benefit the business as a whole. Sellers will need to consider carefully how to approach the buyer to discuss, but it is likely that any buyer will be anticipating and may even welcome such a discussion in the circumstances, particularly where sellers may still be best placed to advise on future performance given their knowledge of the business they sold to the buyer.
We are seeing more and more enquiries from both sellers and buyers with regard to earn-out consideration structures they have entered into particularly as the reality of the impact of lockdown and restrictions on their businesses hits home.

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