What is an ‘Earn Out’ (EO) and what to watch out for?

An earn-out (EO) is a common mechanism during the sale of an MSP business. It is to protect the buyer during the acquisition and to keep the current sellers motivated throughout the process.

When selling an MSP, a figure or valuation calculation is agreed, and this ultimately is the ‘sale price’ for the MSP – However, rather than getting all of the funds on deal day (the day you sign over your MSP), its common practice for a % of the funds to be held back and tied to targets (usually financial targets).

Earn-outs can vary in term length, mechanism, and target levels and often unique to the deal.

It’s important to seek advice during the negotiation on the earn-out terms as it could cost you a lot of money and leave you stuck with your hands tied for the duration which isn’t a good place to be.

Areas to keep an eye on when negotiating an earn-out:

• Earn-out Length – Often based on 12–24-month periods but there is no limit on how they can be structured. When reviewing the length, think about what you want to be doing with your time after the exit and how this will impact it. 24+ months can be a long time if you want to move on. On the flip side, you might be taking a role within the acquirer and your comfortable with a longer earn out period.
  
  
• Targets – Earn out’s are often based on financial targets – These need to be fair, mutually agreed and achievable. Often the seller will have projected financial targets during the sale process that the buyer may adopt.
  
  
• Funds held back – When agreeing an earn-out structure, a % of the fund will be held back and tied to dates, targets or both. Ensure your comfortable with this and the risks.
  
  
• Control – When agreeing an earn out structure and term, its important you ensure you have protection in the agreement that gives you enough control and influence over the business that can impact the targets. Likewise, you want protection that the acquirers can’t make drastic changes during the period that could negatively impact YOUR targets and end figure.

The best outcome of an earn out is a structure that ensures the MSP seller is happy in the role and believes the targets are fair, the seller has protection and is comfortable on their offer and that the legal contracts don’t need to be referred to during the process.