Modeling Impact of Earn-outs?
Can someone explain how to model an earnout?
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Book a liability at close (contingent consideration) for the earnout amount. Goodwill will increase to account for this.
When it comes to paying it make sure you build the logic in dynamically so that if you toggle your cases the earnout will flow automaticslly. I’d leave the IS alone though technically I think you book a loss or gain depending on if you are going to have to pay it. Then you have the payment flow through your cash from financing. If you don’t have enough cash on hand to pay it then you have to build in either additional debt or equity.
That’s pretty skinny and the BS stuff might not really matter if it’s a skinny model vs. a three statement.
It's an exceptional non-P&L expense so indeed no change on the IS. I agree that I wouldn't bother with the b/s portion. To part you forgot is to add the liabilities to your net debt at closing, and as you project to pay the earnout the cash goes out of the door but the liability in your net debt reduces. As a side note you can't raise additional debt to pay earn-outs, no one will finance this - needs to be from cash on hand or equity.
Thanks! So what are the financial statement impacts if they company does not hit the earn-out targets? The contingent liability is forgiven. Do you recognize a gain / pay taxes on the gain? Also do you impair goodwill at all? Do you have to evaluate the contingent liability every quarter or just when the earn-out target is hit / not hit?
Don’t overcomplicate it. The only thing you’ve done by adding an earn out to net debt is telling the seller that he needs to pay for it as you’re paying for the EBITDA in the business plan - ie if he wants you to recognise the financial benefit of his add on in full, then he needs to pay for that said add on in full. If the addon underperforms and doesn’t make the earn out then the contingent liability simply goes away and you remove it from net debt. You’d re-evaluate the earn outs amounts when you reforecsdt the business plan
I would disagree with your point on no lenders would fund an earnout. Depending on your earnout structure if the net result of hitting the earnout is that the portco has additional debt capacity lenders will fund that so long as you’re within the agreed upon leverage ratios / covenants.
I meant the actual cash out amount itself. Clearly you can leverage m&a from the add on
edit: wrong chain
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