As part of our corporate finance team at PKF Francis Clark that specialise in company valuations, I often have clients ask difficult and challenging questions on…
In our latest Noodles and Doodles podcast, Mark Greaves talked to Matt O’Donovan of WiFi SPARK. Matt discussed the sale of his business to a Canadian serial acquirer.
Whilst there were a number of unique characteristics to this specific deal (as there are with most), Matt spent some time focusing on the earn out element of his deal. I have seen good and bad earn out arrangements over many deals, but Matt was quite right in pointing out that whilst they might increase the risks of receiving the consideration, there are a number of factors involved, depending upon how the deal is structured.
Matt started from what has become a usual starting point for many potential vendors:
From what I’ve heard from friends and colleagues who have also sold their businesses, earn outs are a bad thing and are to be avoided because you’re probably going to get stitched up.
However, he then focuses on the key issues – the nature and purpose of the acquirer:
It depends on who’s buying you and what their intentions are. If the business is being acquired to grow and realistic growth targets are set on the business, then earn outs could actually be a good thing. And if you are quite smart as an entrepreneur, you should know what your business prospects are and what its capabilities are likely to be in the future. And you balance that off against the offer that is made, such that your earn out is something that you know you can achieve. If you know you can achieve it and you’ve got an organisation who wants to buy you and keep you forever, you’ve got a very good chance of hitting that earn out.
The key point here is confidence in the ability of the business to meet set targets and also knowing the buyer will give you the freedom to achieve these. Although it is a bit of a truism, from our experience, we have seen a direct contrast between Canadian (for Matt’s acquirer) and American acquirers, with the former being more silent partners.
Matt also comments on the ability to change earn outs when circumstances change:
the earn out that I was presented with was very reasonable. Year one, did great, but in the middle of year one, we went out and acquired another business, which changed the landscape a bit. …I discussed with our buyer, Volaris, to say, ‘Look, it’s a bit of a different picture now, and this may have an effect on my earn out, what do you think?’ And they said, ‘No problem. Let’s change it. And let’s adapt it. We still want you to grow the business, but we’re prepared to do this and to do that for you.’ I’m honestly blown away by how supportive they have been for me to achieve what I need to or want to from the earn out. So having the support from an organisation will be there if they are going to succeed, if you succeed, if it’s a mutual benefit.
And for the case of SPARK, Matt also comments on the mutual benefits angle:
I guess what I’m saying is, if you’re going to have an earn-out, make sure that it’s not just you that benefits from it or the targets of the earn out, but it’s the acquiring organisation. So what is the benefit to the acquiring organisation if your earn out says, you’ve got to double your EBITDA after three years? If that’s going to make a massive difference .. then you know they will do everything they can to support you in getting your earn out.
Overall, earn outs can work within an overall deal, but they do need specific work and the right acquirer – as ever you need an experienced adviser here to guide you through the details and structure it appropriately.
It’s great that Matt has found the earnout part of his deal to be so rewarding – as have many other clients. The crucial point is negotiating the detail around the terms, with some clients even doubling the overall value of their deal through the earn-out.
Listen to the full episode with Matt below or by searching for Business Noodles and Doodles on your usual podcast platform.