February 19, 2021

Earnouts: Still Popular – And Still Problematic

Earnouts have long been a popular tool for bridging valuation gaps, and they’ve been particularly popular in life sciences transactions.  A recent Cooley blog reviewing 2020 M&A in the life sciences sector says that they remain both very popular among dealmakers in this sector – and very problematic:

Earnouts continue to be popular methods for addressing valuation uncertainty, particularly in the life sciences space. As we have previously observed, the use of milestone-based earnouts to bridge a valuation gap is often a short-term solution that presents many long-term complications. In October 2020, the representative of the former shareholders of surgical robotics company Auris Health filed suit against Johnson & Johnson in connection with the $5.7 billion deal inked in 2019 that included more than $2 billion in contingent payments based on the achievement of certain milestones.

The Auris shareholders argue that J&J never intended to make the milestone payments. The complaint alleges that J&J interfered with the achievement of the milestones by transferring employees from another robotics company acquired by J&J into the Auris unit who slowed down development, refusing expansion requests and slow-walking efforts to obtain FDA approvals. Not surprisingly, the parties appear to disagree over whether “commercially reasonable efforts” were used in connection with attempting to achieve the milestones as required by the merger agreement.

The repeated willingness of parties to sign-on to earnouts in order to get deals done seems to make them an equally worthy of Samuel Johnson’s quip about second marriages – like those nuptials, they represent the triumph of hope over experience.

John Jenkins