Acquiring an existing business comes with some challenges. While the buyer is likely getting a talent pool and an established customer base, there is no guarantee that the target company will live up to its price tag. In fact, particularly when the valuation of the existing business is lofty, the buyer should consider using earnouts as a way to protect his or her interests in the transaction.
Essentially, with an earnouts, the buyer will pay only a portion of the purchase price for the existing business, while making the balance of the purchase price contingent on the future performance of the business. Consequently, the seller may receive the remainder of the price if revenue, market-share, and cost-control milestones are met.
Because this approach can get complicated, the buyer and seller are well-advised to clearly negotiate the performance milestones, and the metrics used to measure them, in advance of reaching an agreement, while also setting the terms for payouts and their timetables.