New accounting rules may require that acquirers and acquiring companies report earnout agreements as liabilities.
Joel Johnson, president of Orchard Partners Inc., in his article, “Earnouts,” published by Valuation Strategies, states: "In a given year, 2% - 3% of announced mergers and acquisition agreements involve earnouts. These figures probably understate their prevalence. Earnouts tend to be a characteristic of smaller deals; and in many small deals, terms are not announced. Earnouts are rare when public companies are acquired and more common when ownership is concentrated among a few shareholders."
This would mean, if implemented, that earnout agreements must have a value placed on them for accounting purposes. As Joel Johnson points out, “The higher the earnout, the greater the liability.”
Why the Earnout?
Johnson further states that earnouts are used for various reasons:
1. to bridge the pricing gap between the seller who places a heavy emphasis on the company's projections, and the buyer who places most of the company's value on its present and past performance. 2. to tie the acquisition payout to future performance. 3. to create a form of seller financing in that some of the buyer's purchase price is delayed into the future. 4. to establish a form of escrow account in that the money is paid on condition of meeting certain thresholds. 5. to act as a type of employment agreement in that the CEO has to stick around in order to collect.
Creating value in the privately held company makes sense whether the owner is considering selling the business, plans on continuing to operate the business, or hopes to have the company remain in the family.
Keep in mind that the best time to consider selling is when business is good, the business is running profitably, and many of the above “value-adders” are in place.
Statistics reveal that out of about 15 would-be business buyers, only one will actually buy a business. It is important that potential sellers be knowledgeable on what buyers go through to actually become business owners. This is especially true for those who have started their own business or have forgotten what they went thorough prior to buying their business.
41% joined the family business;36% wanted more control over their future...
Why does it take so long to sell a business? Price and terms are the biggest reasons.
Today's independent business marketplace attracts a wide variety of buyers eager for a piece of ownership action. Buyers of small businesses are most likely replacing lost jobs or searching for a happier alternative to corporate life. Buyers of mid-sized and large operations are, typically, private investment companies seeking businesses to build and eventually sell for a profit.
Selling one's business can be a traumatic and emotional event. In fact, "seller's remorse" is one of the major reasons that deals don't close.
The following is some basic information for anyone considering purchasing a business. Is may also be of interest to anyone thinking of selling their business. The more information and knowledge both sides have about buying and selling a business, the easier the process will become.
Once the decision to sell has been made, the business owner should be aware of the variety of possible business buyers. Just as small business itself has become more sophisticated, the people interested in buying them have also become more divergent and complex.
If you are considering entering the world of franchising, an important consideration is assessing the value of the business. All of the following factors either affect or help determine valuations of typical franchise operations.
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