In the world of mergers and acquisitions, so called “earnout” provisions are sometimes utilized to bridge differences between a seller and a purchaser as to the value of the target company. The purchaser may take the view that it will not pay additional consideration for the target unless the target company performs well over a period post-closing, in which case additional consideration is paid referencing the achievement of an agreed upon metric.

Generally, earnout provisions are not readily accepted by a seller because of the myriad of potential issues that affect the calculation of the additional “earnout” consideration. One such issue is how the business of the target company is conducted post-closing. The purchaser will want complete discretion on how to operate the target or acquired company post-closing and will not want to undertake an obligation to maximize the earnout payment. The seller, on the other hand, is usually quite uncomfortable with allowing the purchaser such complete control. After all, the business may have performed very well prior to the sale and the seller will want the acquired company operated in the ordinary course in accordance with past practice. Horizon Holdings, LLC v. Genmar Holdings, Inc., 244 F. Supp. 2d 1250 Kan. 2003 involves a disputed earnout provision.

Failing to be specific in the purchase agreement about how the acquired company should be operated post-closing when an earnout provision applies is fraught with peril and may very well result in litigation. There are several possible ways to address the issue of how the acquired company will be operated post-closing, some of which have been suggested above. The important point is that the purchase agreement should be very clear on this issue of how the acquired company will operate post closing, and parties involved in an acquisition need to pay as much attention to this issue of post-closing operation as they do to any other aspect of the earnout provision.