The Concept of Earnout in Merger and Acquisition Transactions

20 Pages Posted: 9 Dec 2013 Last revised: 21 Mar 2014

Date Written: November 29, 2013

Abstract

This research paper throws light on assessment on merger and acquisition (M&A) deals based on earnouts. It is often said that M&A transactions involving earnouts possess option-like features, and thus this research paper using a theoretic approach to model the value of such observations made. Moreover, the impact of uncertainty on the optimal timing of M&A using earnouts has been dealt with in this paper. This paper shares a dynamic decision-making approach of the invest-to-learn option which is generated on account of investment made in an acquisition. This research paper also provides the implications of earnouts applied in M&A transactions.

It has been found that earnouts provide best hedge to the acquiring companies for minimizing the risk of adverse selection in acquisitions. The reason being earnouts enable an acquiring company resolve the problem of over-valuation and that of non-performance by making part payment contingent on the ex post performance of the target company as well as by retaining target company’s managers respectively. The paper recommends earnouts as a valuable strategy for the acquiring companies in the emerging markets for their future global acquisitions as these companies usually end up overpaying the target companies due to lack of expertise in acquisitions. The paper has tried to fill the void in the existing literature by explicitly analyzing the impact of the different modes of payment on the risk profile of acquiring companies in the post acquisition period.

Keywords: earnout, merger, acquisition, law

Suggested Citation

Sehgal, Anshul, The Concept of Earnout in Merger and Acquisition Transactions (November 29, 2013). Available at SSRN: https://ssrn.com/abstract=2365020 or http://dx.doi.org/10.2139/ssrn.2365020

Anshul Sehgal (Contact Author)

Amity Law School, New Delhi ( email )

Sector 16 C, Kashmere Gate
Dwarka
New Delhi, DE 110078
India

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
463
Abstract Views
1,944
rank
72,205
PlumX Metrics