September 15, 2005

Negotiating your earn out deal

Today, a lot of start-up acquisitions come with a “earn-out” provision for the founders – i.e., a part of the payment that is linked to their sticking around and meeting some performance targets. A Business Week article advises entrepreneurs on how to deal with the earn out agreement.

The key to a successful earnout lies in negotiating smart, achievable targets, making sure they're spelled out clearly in your contract, and keeping some power over decisions that directly affect them. You'll also want to nail down your own position in the new company -- and your eventual exit from it.

...Many experts recommend using revenue targets instead (of profits). "It's harder for buyers to do things that will depress sales than to depress income," says Mihanovic.

...No matter which type of target you use, fight for sliding-scale rather than all-or-nothing payments. That ensures that "if you're within 80% of the threshold, you'll get 80% of the payout," says Dexter. Ask also that disagreements over how costs are determined be submitted to binding arbitration.

...Then there's the unenviable task of trying to guess the future. What if the acquiring company gets sold? Or goes public? What if your division gets transferred overseas?

...The last task is getting your own employment contract. Without one, "They can pull the rug out from underneath you," says Phil Thompson, a partner with Thompson Associates, a law firm in Richmond Hill in Ontario, Canada.

Arun Natarajan is the Founder of Venture Intelligence India, which tracks venture capital activity in India and Indian-founded companies worldwide. View sample issues of Venture Intelligence India newsletters and reports.