Contemplating Contingent Consideration
A look at the potential benefits and challenges
Although contingent consideration or earn-out clauses are vehicles that can be effectively used in transactions to help buyers and sellers agree on price and achieve other objectives, they can also have significant tax and valuation implications, and often result in post-closing challenges and disputes. However, managing expectations at the beginning of the negotiations for the seller and the buyer can help mitigate these challenges.
Earnouts are possible future payments to the seller that are contingent on future earnings or other performance measures of the acquired company. Earnouts are most commonly used when traditional financing is tight and there is more than usual near-term economic uncertainty. There are significant factors for both parties to consider when using earnouts and negotiating the sale of property or assets. For example, earn-out provisions can significantly impact the timing of a seller’s U.S. federal income tax liabilities. Therefore, it is wise to use advisors who are experienced in structuring earnouts and who understand the tax, valuation and post-closing challenges in a sale so that these advisors can help you mitigate post-closing issues.
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