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Ask Ryan Reynolds: earn-outs can spread risks, but beware the traps

Corporate and M&A
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Corporate and M&A partner Jonathan Wenig used the amusing story of Deadpool star Ryan Reynolds’ premature out-of-office bravado following the sale of Aviation American Gin to explain the complicated risk/benefit analysis around earn-outs.

In a column published in today's Australian, Jonathan explains that the Ryan Reynolds experience provides "a sobering reminder that selling a business isn’t always quite as straight forward as signing on the dotted line, popping a bottle of champers and walking (or stumbling) away with the proceeds."

"When Reynolds’ lawyers explained the term to him, they would have put it as simply as possible for a non-lawyer: an earn-out is a mechanism for a seller to receive future payments after completing a transaction, based on the business achieving specific performance milestones.

"Typically, earn-out clauses written in sale agreements capture how the potential future payments will be calculated, when they will be made and the buyer’s obligations during the earn-out period. The parties can include specific performance hurdles or thresholds that the business must meet for the seller to receive the additional earn-out payment. Earn-outs can be a useful tool in bridging the gap between what a seller thinks a business is worth and what a buyer is willing to pay."

As far as the buyer is concerned, Jonathan writes, the upsides of an earn-out are that it keeps the initial price lower and ensures that the seller continues to have skin in the game when it comes to the future success of the business.

"In this case, with Reynolds' personal brand so closely associated with Aviation, his ongoing involvement was clearly worth a great deal to Diageo Plc. Often the risk/benefit analysis of an earn-out is far less straight forward. 

"It’s the cliché of 2020 to say that it’s difficult to predict the future for a business. But even in more normal circumstances than we find ourselves in right now, tying outcomes and payments to future events and triggers is tricky."

Jonathan was assisted in writing the article by law graduate Chooi-An Khoo.

To read the full article, click here.

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