Asset Purchase Buy With Earn-out Provision
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FAQ
Generally, an earn-out will be treated for tax purposes as part of the purchase price. However, if the selling shareholder will continue to provide services to the company, it is possible that the amount will be considered compensation for services.
Earnouts determined to be part of the business combination (i.e. consideration) are measured at fair value at the acquisition date, and enter into the calculation of goodwill. After the acquisition, accounting for changes in the fair value of earnouts depends on whether they are classified as equity or liability.
If an entrepreneur seeking to sell a business is asking for a price more than a buyer is willing to pay, an earnout provision can be utilized. In a simplified example, there could be a purchase price of $1 million plus 5% of gross sales over the next three years.
Earnout provisions, or contingent purchase price agreements, allow buyers to limit their upfront payment and spread the purchase price over time. From the seller's perspective, earnouts can provide an opportunity to receive additional compensation based on the future performance of the acquired business.
Views of Sellers and Buyers Earnouts are often used to bridge pricing gaps between buyer and seller. For example, the seller wants $100 for its business, but the buyer is only willing to pay $75 at closing. However, the buyer is willing to pay an additional $25 after closing if certain post-closing milestones are met.