I know this has been posted about before but haven't found a clear answer.
How would you model an earn-out in the sources and uses as well as for the rest of the model including closing balance sheet? Lets assume the total EV is 1000 (10x EBITDA) and all debt is refinanced. we assume LBO leverage of 6x and the rest sponsor equity. 80% of the consideration is paid at closing, and the remaining 20% in year 3 (lets assume the condition for earn out is reached)
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My initial thoughts is to do as follows and per the BIWS earn out video on youtube:
S&U only reflects what is paid out on day 1. Thus we would get:
Sources:
- LBO debt: 480 (6x/4x is implies 60% debt funding)
- Sponsor equity: 320
Uses:
- Purchase price (initial): 800
On the purchase price allocation, we assume increase goodwill by the amount of the deferred consideration as we recognize a deferred consideration amount which is a liability. This then balances as GW is increased by the same amount as on the liability side.
When and if the deferred consideration is paid out, we consider this a cash outflow in the income statement and write off the liability. Nothing is done with regard to exit calculcations as the cash reduction already decreases equity. The earn out could also be funded by new debt but in this case we assume cash
Another way to structure an earn out would be to add in a seller's note which would be included under "Sources" in the S&U table.
Is the earn out typically paid out through additional equity injected in the business by the sponsor? If the vendor rolls equity and has an earn out and the earn out is paid from cash generated by the company or additional debt, then isn’t the earn out partly paid for by cash that the vendor is entitled to?
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