How would you calculate earnout payments to the seller from company cashflow when the seller is also rolling over minority equity?
Assume:
No debt for easy of calculation
$100 enterprise value = $60 cash + $20 roll-over + $20 earnout paid in 2 years (assume 10 each and contingents met in year 1 & 2)
Buyer = 75% of the equity
Seller = 25% of the equity
Question:
If the company pays $10 in earnout, does it meant that the buyer is paying the seller only $7.5 through the company and that the buyer is paying himself $2.5 since he owns 25% of the company?
How is the earnout normally structured? (payment from company CF or seperate payment from equity sponsor)
Thanks
Earnouts are paid from company CF to management/seller and has nothing to do with the ownership structure of the equity. In this case, $10 of earnout is paid from company CF every year to the seller (assuming it was seller earnout and not management earnout).
Thanks for the reply!!
I think I didn't ask my question in the best way possible
Assume the seller sells 100% and will get $1M earnout every year for 3 years In this case there is no difference between paying the seller using the company CF or using the buyer's additional equity outside of the company (becasue the seller doesn't own anything)
However, if the seller roll-over a minority, say 10% Now if we pay the seller $1M, 10% of that $1M, or $100K, is actually the seller moving his $$ from one pocket to another, + paying tax of some sort, depending on the structure (dividend, stock warrants, etc)
So what I am interested in learning is, if there is any clever way to pay the earn out using the company's cash flow rather than putting in additional equity, at the same time minimizing tax burdens to the seller, the buyer, and the company.
Comment above covers it. Just to add another example - if a sponsor sells its stake in a company, even with 0% ownership when the earnout is achieved X years later, it will still receive its portion (probably by % ownership prior to the transaction depending on transaction arrangements)
Thanks for the comment!
I added a response above ^^
Think of it as similar to a sponsor paying themselves a divided from FCFs (i.e. they have sponsor equity in the business and are funding the div using company FCF).
The funds from the dividend would have otherwise been used to repay debt (and thereby increase the proportion of equity at exit).
Therefore, ceteris paribus, you are reducing the equity cheque at exit by paying this dividend, however you're boosting your IRR by receiving capital today.
With regards to who pays the earnout, it will almost always be funded by company FCFs (not via sponsor equity).
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