At the end of May, e.l.f. Beauty announced they signed a definitive agreement to acquire rhode, a lifestyle beauty brand founded by Hailey Bieber. The $1 billion deal's structure is comprised of:
- $600 million in cash on closing
- $200 million in shares on closing
- $200 million in earnout consideration based on the future growth of the brand over 3 years following the closing
Earnouts are a commonly used tool in deals to reduce the amount of up front consideration that needs to be paid on closing. It allows the seller to receive additional consideration based on hitting specific financial or operational performance targets following closing (e.g. revenue, EBITDA or product development milestones). The structuring of the rhode transaction helps highlight a few reasons why parties may want to consider including an earnout when negotiating a sale:
- Bridges a Valuation Gap: buyers and sellers may be too far apart on their valuation of the business. With an earnout, the company can be valued on actual future performance as opposed to past performance or predictions on future performance.
- Smooth Transition: in many cases when there is an earnout, the founder or key management stays on after the sale. This motivates sellers to remain involved and maximize the profitability of the company since a portion of the purchase price is contingent on the performance of the company following the sale. Following the sale of rhode, Hailey Bieber will serve as rhode's Chief Creative Officer and Head of Innovation after the sale of rhode, overseeing creative, product innovation and marketing.
- Reduces Buyer's Risk: buyers do not want to overpay, so an earnout allows them to pay less upfront and only more if the business performs, tying their financial commitment to actual performance. Sellers may also end up receiving a higher purchase price than it would otherwise have received.
While earnouts offer a number of opportunities, there are some challenges and risks to earnouts, including:
- Disputes: earnouts often lead to disagreements about whether or not the targets were met.
- Manipulation: the buyer may have control over operations and could make decisions that affect earnout results.
- Complexity: they add legal, financial and operational complexity to the deal.
With clear drafting, earnouts can offer strategic advantages to buyers and sellers—as evidenced in e.l.f. Beauty's acquisition of rhode. Earnouts, when done properly, offer strong strategic value to transactions, rewarding the seller for continued growth and the buyer a more secure investment. Earnouts can be a secret ingredient to help an acquired company remain healthy and beautiful.
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