M&A in Hong Kong: Earnouts

• Published date: 24 May 2022
• Subject Matter: Corporate/Commercial Law, M&A/Private Equity
• Law Firm: Timothy Loh
• Author: Mr Timothy Loh

An earnout is a pricing mechanism in a merger and acquisition ("M&A") transaction whereby a purchaser will make a payment to the seller upon the target business being acquired having met some pre-agreed metrics relating to its financial or operational performance after completion. In this article, one of a multi-part series on M&A, we examine some of the issues which a seller and a purchaser may wish to consider when structuring an earnout in a purchase and sale agreement. In other articles, we look at a range of issues including the use of a letter of intent in an M&A transaction, due diligence and representations and warranties, financial assistance for the purchase of shares, and the key terms of an asset purchase agreement and a share purchase agreement. Readers who may be contemplating an M&A transaction may contact our M&A lawyers for more specific information tailored to their individual circumstances.

Table of Contents

• What is an Earnout?

• Performance Metrics
• Financial Metrics
• Non-financial Metrics

• Payment Structure & Milestones
• "All or Nothing" Binary Payment
• Graduated Variable Payment
• Caps and Floors

• Benefits of an Earnout for a Buyer

• Risks of an Earnout for a Seller

• Post-Completion Restrictions
• Operational Consistency
• Extraordinary Items
• Change of Control
• Affiliate Transactions
• Non-Arm's Length Transactions
• Access to Information

In M&A transactions, sellers and purchasers often have different views on the value of a target business and hence, different views on how the target should be priced. Not uncommonly, a seller may be more confident about the business prospects of the target and will seek a higher purchase price to reflect its optimism for future growth. On the other hand, a purchaser is not infrequently more conservative about such prospects and will seek a lower price to minimize the risk of any overpayment.

What is an Earnout?

An earnout is a methodology for pricing an M&A deal which is commonly used to bridge valuation gaps between the seller and the purchaser. It is a payment mechanism whereby the purchaser will, after completion, pay to the seller an additional purchase price (known as an "earnout payment" or simply "earnout" or "earn-out") upon the satisfaction of pre-agreed conditions. These conditions aim to tie the total consideration paid by the purchaser to the seller to the post-completion performance of the target business. Earnouts are often payable subject to the fulfilment of some financial or...