Earn-out modelling LBO

Hi, if the sponsor pays an extra x$ through the holding period as earn-out to the seller, how do i model this correctly given min cash balance and full cash sweep?

Tried plugging it into the CFS under Cash flow from investing, but BS doesnt balance (debt just lower however asset side stays the same).

Do I have to model a contingent liability (thought this is only modelled if earn-out is part of the initial transaction value, e.g. if only 80% paid at closing)

Thank you!

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Comments (13)

  • Analyst 3+ in Consulting
Nov 21, 2021 - 4:49am

its part of modelling test; stating the PE will pay x$ additional in year x if EBITDA bigger than x.

I see two options here; either putting a contingent liability on the BS, which gets reduced in year x (simplified not as write down on IS but just as payout on CFS so it balances) OR at exit, by substracting the amount of the earnout from the overall Equity available.

  • Analyst 1 in IB-M&A
Nov 21, 2021 - 5:24am

It seems like this is just a yearly hurdle then, right? If EBITDA > Hurdle, then subtract XXX from the cash before debt paydown and give that to whatever party is earning that, right? 

  • Analyst 3+ in Consulting
Nov 21, 2021 - 5:32am

But how is that balancing in the model with Min cash assumption? Liabilities side will be higher by the reduced cash otherwise used for debt paydown (debt higher), but there is no offsetting balance

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  • Analyst 1 in IB-M&A
Nov 21, 2021 - 5:57am

Free cash flow

(-) mandatory debt repayments

FCF after debt paydown

Plus: beginning cash balance

Less: minimum cahs balance

Cash available to paydown debt -> this is the number that gets affected by the earnout

Nov 21, 2021 - 1:51pm

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