Earnouts in M&A deal negotiations are a vital tool, offering sellers of fast-growing companies potential extra compensation and providing buyers with a risk-reduction method. But do earnouts consistently bridge the gap between buyers and sellers in Consulting and Professional Services deals?

In the realm of Consulting businesses, where the primary assets are often intangible—knowledge, relationships, and expertise—maintaining these assets post-acquisition is paramount for buyers. Earnouts serve as a mechanism to ensure key personnel, particularly revenue-generating owners or leaders, remain with the company.

Consider a scenario I encountered involving a fast-growing consulting firm. The buyer, eager to meet the seller’s value expectations, structured 40% of the total price as an earnout spread over four years. However, negotiations hit a snag when the seller proposed retaining total operational control during the earnout period.

Despite the potential value at stake, the buyer balked at the idea of relinquishing control, envisioning strategic integration and synergy across their portfolio of Professional Services businesses. Ultimately, the deal collapsed due to irreconcilable differences.

What could have salvaged this deal? Three key considerations emerge:

  1.  Optimized Earnout Structure: A smaller total potential value from the earnout could align buyer and seller perspectives on current value and future growth, fostering agreement.
  2.  Shortened Earnout Period: A shorter earnout timeframe would expedite integration efforts, facilitating smoother collaboration between the acquired firm and the buyer.
  3.  Establish Trust: Past dealings or interactions between buyer and seller could build trust, minimizing conflict and enhancing negotiation outcomes.

By incorporating these factors, future earnout agreements can effectively bridge the value gap between buyers and sellers, ensuring mutually beneficial outcomes.

Kelly L. Kittrell has more than 30 years of merger & acquisition and corporate finance experience. He advises business owners on sell-side and buy-side transactions, valuation analysis, corporate finance and equity and debt financings. He is based in Dallas.