Back in April 2015, we
discussed key questions to keep in mind when negotiating
earn-outs, and looked at recent trends coming out of the American
Bar Association's 2014 Canadian Private Target M&A Deal
Points Study (the 2014 ABA Study). As the ABA has
now published its 2016 study (the 2016 ABA Study),
we thought it may present a good opportunity to revisit the topic
and look at some key earn-out trends.
General use of earn-outs
The 2016 ABA Study showed a decrease of earn-out clauses present
in the transactions surveyed down to 17% from the 25% level in the
2014 ABA Study, and the 21% level in the American Bar
Association's 2012 Canadian Private Target M&A Deal Points
One of the most important steps in structuring an earn-out is
determining and clearly defining the performance metrics to be
used. Based on the 2016 ABA Study, it seems that financial metrics
are becoming increasingly popular. Out of the earn-out clauses
evaluated, 25% of them used top-line revenue as a metric and 38%
used an earnings based metric, while only 19% (down from 53% in
2014) used some other form, which included non-financial metrics.
While sellers will typically tend to prefer more clear cut and
harder to manipulate metrics such as revenues, and purchasers often
prefer an earnings-based metric (having valued the transaction
based on earnings), there are some isolated instances (6% in the
2016 ABA Study) where the parties have structured the earn-out
using both revenue and earnings metrics.
Earn-out periods between one and three years have consistently
been the most common in terms of Canadian M&A transactions in
recent years. The 2016 ABA Study is notable in that there were no
transactions that used an earn-out period of four years or longer,
compared to 20% in the 2014 ABA Study. It is possible that
companies are finding that longer earn-out periods are
unnecessarily delaying full integration of the business, or that
sellers are unwilling to increase the long-term performance risk
they take on, particularly as their impact and influence on the
organization's performance would typically be expected to
decrease over time.
One trend that is picking up steam is the inclusion of express
acceleration provisions in earn out mechanisms, which are triggered
upon the occurrence of certain events. As discussed in our previous
post, an acceleration of the earn-out can be beneficial to the
purchaser or the seller depending on the circumstances. The ability
for a purchaser to "buy-out" an earn-out payment can
provide for greater flexibility if the future of the company is
different than what was predicted. This may be the reason for the
sharp increase of earn-out transactions containing an express
acceleration clause. While only 7% of transactions contained such a
clause in the 2014 ABA Study, the 2016 ABA Study found that 31% of
transactions had an express acceleration clause.
While the total number of earn-out clauses present in the
transactions surveyed by the ABA decreased from its previous study,
they still remain a useful tool to benefit both the purchaser and
the seller, and should be carefully considered when completing a
The author would like to thank Simone Nash, articling
student, for her assistance in preparing this legal
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