June 10, 2020
Revisiting Earnouts During the Covid-19 Era
One of the consequences of the Covid-19 pandemic is that buyers and sellers are increasingly finding themselves in situations where they need to find a way to bridge a valuation gap in order to get a deal done. One tried and true – if frequently troublesome – way of doing that is through the use of earnout provisions.
If you are considering an earnout, check out this recent article by Mintz’s Marc Mantell & Scott Dunberg, which updates the authors’ 2014 article & reviews how market practice on key earnout issues has evolved in recent years. Here’s an excerpt on contractual provisions addressing the buyer’s obligations when it comes to achieving earnout milestones:
Notably, there may be an upward trend in covenants requiring buyers to operate the business to “maximize” the earnout payments to sellers. As we noted in the 2014 article, the 2013 ABA Private Target Mergers and Acquisitions Deal Point Study, reported that only 6% of deals covered in that study included such a covenant.
However, the 2019 ABA Study reports that 17% of deals with earnouts included an express covenant requiring the buyer to run the business to “maximize” the earnout. This is a surprising result, as it appears to reverse the trend reflected in prior studies and could signal a strengthening of sellers’ bargaining power. However, based on our independent review of several publicly-filed acquisition agreements, including those in the 2019 ABA Study, many of these provisions invoke a “commercially reasonable efforts” or similar standard to the effect that the buyer’s obligation is to use commercially reasonable efforts to maximize the earnout payments, or some variation of this language.
The article also looks at how judicial interpretations of the implied covenant of good faith and fair dealing in the earnout context have evolved in recent years, as well as the impact of RWI on provisions relating to set-off rights.
– John Jenkins