It is pretty straightforward: draft your agreement with precision, transparency and structured processes:
- Draft with Surgical Precision: Define every metric and adjustment in unambiguous, “if-this-then-that” terms—e.g. “Adjusted EBITDA = net income + D&A + X add-backs, excluding any parent overhead allocations”. Appending a worked numerical example so there is no question how the math runs should be mandatory.
- Lock In “Efforts” Covenants With Specificity: Do more than use generic “best efforts”–you are being paid a lot of money! There is no reason why you cannot spell out buyer obligations (such as “maintain marketing spend ≥ 5% of revenue; retain headcount at January 1 levels unless mutually agreed”). Post-COVID, carving out true “force majeure” or bona fide restructuring moves is strongly advised so the buyer has guardrails but still can adapt as neessary.
- Build Transparency into Reporting: Set a rigid calendar. Monthly or quarterly draft statements must be delivered by a particular fixed date. The seller needs to have reasonable review rights over source documents. Requiring joint “earn-out calls” whenever a shortfall looms. The phrase “an ounce of prevention is greater than a pound of cure” for a reason.
- Be Creative In Your Dispute Ladder:
- Have the businesspeople meet first. This can be in person or via Zoom.
- Mandate mediation with costs split 50/50 between the participants.
- Pre-select the mediator. The best course of action is to have the attorneys agree upon a retired judge with a great reputation as a mediator.
- Your arbitration clause need not follow the law. The prevailing party may be able to receive three times the total cost of the mediation–why limit yourself to the strictures of contract law.
- Seller Involvement: The seller can hold an advisory seat or a full or partial veto on material strategic shifts that could skew targets.
- Seller Comfort: Holding a minimum escrow pool so funds are immediately available if metrics are met will calm (rightfully!) nervous sellers.
- Meticulous Record Keeping: Every business decision (date, author, rationale) that could affect earn-out drivers should be documented and explained. Sharing projected vs. actual models of the earn-out metric(s) shows the buyer is confident that is has written proof that is not intentionally depressing your payout.
- Tailor to The Business: Boilerplate language should be avoided to the greatest degree possible. Map out each of the specific value levers and accounting quirks in the relevant industry sector—SaaS and manufacturing deals require different sets of considerations. Likewise, think about using earn-out language that reflects how the acquired business actually runs.
Clarity. Accountability. Transparency. Bespoke. These are words that should define an attorney’s work at all times.
David Seidman is the principal and founder of Seidman Law Group, LLC. He serves as outside general counsel for companies, which requires him to consider a diverse range of corporate, dispute resolution and avoidance, contract drafting and negotiation, and other issues. In particular, he has a significant amount of experience in hospitality law by representing third party management companies, owners, and developers.
He can be reached at david@seidmanlawgroup.com or 312-399-7390.
This blog post is not legal advice. Please consult an experienced attorney to assist with your legal issues.
Photo credit: GenTech
