A hallmark of a company’s success is often the pursuit of that company by a suitor purchaser. For the shareholders being courted, many are not mere passive investors; they are the founders, the ground-floor believers, and the proud owners of sweat equity. And they duly expect just compensation in order to part with the start-up company and its innovative products they have built into such an attractive target.
But many would-be purchasers are not willing to offer a full cash payment for the shareholders’ company. Instead, they seek to defer portions of the purchase price through contingent “earnout payments.” That is, the suitor offers a smaller up-front payment, along with a promise to make “commercially reasonable efforts” to hit certain sales, revenue, or other milestones for the acquired products—often years down the road. The purchaser thus pays the shareholders these “earnouts” on the back end… and on the if-come.
This increasingly common acquisition model is not without potential advantages for shareholders—earnout payments can fetch longer-term compensation well in excess of what a purchaser is able to offer up-front. But these arrangements and their commercially reasonable efforts (“CRE”) clauses (sometimes framed as “best efforts” or “reasonable efforts”) are also fraught with potential pitfalls; the devil is most certainly in the details.
Whether the commercial efforts the acquirer is bound to exert are measured vis-à-vis the acquirer’s efforts toward its own products (“inward-facing”), or efforts generally recognized in the industry (“outward-facing”), fundamental to any such purchase agreement is that selling shareholders cede control over the products they developed into the prizes of the acquisition. And even with the purchaser bound by contract to exert CRE to meet the target, the path from paper to practice is only as straight as the purchaser travels it. Too often, the purchaser is unable – or even unwilling – to commit the level of resources, training, and related efforts to prime its own sales and marketing organization to achieve the milestones necessary to trigger an earnout payment. Predictably, this is especially true when the acquiring company is a competitor of the selling company.
The first line of defense for shareholders is, of course, to engage counsel to negotiate and craft the most advantageous purchase agreement possible—with the most seller-friendly earnout terms possible. But even under the most well-crafted contract, post-closing disputes arise. And when a milestone period elapses, and shareholders receive notice that the purchaser failed to hit the target necessary to trigger an earnout payment, shareholders’ first line of offense is to engage counsel to explore claims against the acquiring company.
The Miller Law Firm is ready to assist shareholders in evaluating their options when an earnout dispute arises. Whether in litigation or arbitration, we are committed to helping shareholders realize the full value of the company and products they worked so hard to bring to market.