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4 Things To Consider Before Agreeing to an Earn-Out Deal

In this week’s edition of Built to Sell News, we cover 4 things to consider before agreeing to an earn-out:

  1. Are you happy with “day 1 money”?
  2. What’s your earn-out tied to?
  3. Can you hit your first milestone?
  4. Do you know when to leave?

In 2017, Chris Mole founded UK-based Molzi, a full-service digital marketing agency catering to Amazon sellers. As a pioneer in the field, the company witnessed significant growth. By 2020, amidst the pandemic fuelled e-commerce boom, Molzi doubled in size to over 70 employees, generating £4.5 million in sales. (Listen Now)

In 2021, their success caught the eye of Brainlabs, which acquired Molzi, paying 75% of the purchase price up front and committing the remaining 25% to an earn-out agreement.

Getting 75% of his money upfront was a coup for Mole, who had received more than a dozen inquiries from potential acquirers, most of whom were offering Mole around 25% cash up front with the balance of his consideration paid in a multi-year earn-out scheme.

Based on our conversation with Mole, here are four things to consider before accepting an earn-out deal:

  1. Are You Happy with “Day 1 Money?”

Day one money — also referred to as your “downstroke” — is the money that you get when you close the transaction and start your earn-out. Mole recommends ensuring you’d be happy with the deal if the earn-out funds never materialize.

If you want to maximize your day 1 cash, you’ll need to prove to an acquirer that your business can run without you. VidGuide is a simple tool to help you prove to an acquirer that your business isn’t reliant on you. Sign up for a free 30-day trial today.

  1. What’s Your Earn-Out Tied To?

As the name suggests, most earn-outs are pegged to your earnings as a division of the company that acquires your business. However, once you sell your company, you may lose control of the finance function, which often moves to the head office where random costs from headquarters and subjective accounting decisions can make it impossible to hit your earn out.

Instead of tying your earn-out to EBITDA, Mole recommends getting your earn out pegged to something you can control, like sales.

When Rob Walling sold the email marketing platform Drip, he tied his earn-out to the release of a product feature. Since he controlled the development team, he knew he could deliver on his promise and hit his earn-out.

  1. Can You Hit Your First Milestone?

Most earn-out schemes are stage-gated by year, which means if you don’t hit your first goal, it can be virtually impossible to hit year two and so on. In some cases, the budget to hit year two goals is only released by HQ unless you hit year one’s budget.

Once Rod Drury sold AfterMail, he needed some time to celebrate and decompress. By the time he processed the sale and started to work on achieving his earn-out, he realized it was too late. He had let too many months slip by and reaching the goals contemplated in the earn-out was now possible. He left, walking away from a $20 million earn-out.

  1. Do You Know When to Leave?

Most owners we’ve interviewed on Built to Sell Radio found their earn-out period to be stressful and unpleasant. At a time when you should be celebrating – after all, you’ve just sold your business – you find yourself on a hamster wheel of chasing goals you influence but may not fully control. For an owner who has grown up with total control, it can be incredibly stressful.

Mole found the first year of his three-year earn-out intense. They hit their goal, but it was exhausting. Halfway through year two, Mole realized they were never going to hit the year two goal, so he bailed out, leaving part of his earn out on the table.

📽️ Clip of the Week

In this clip, Mole reveals the advice he received from one of his investors on structuring an earn-out.

📣 Quote of the Week

” No matter what’s going on in your business and the growth trajectory you’re on, you don’t know what lies ahead, so just make sure you’re happy with day 1’s money.”

__

–  Mole’s advice to founders who agree to an earn-out when selling their business. 

🏆 A Trophy Every Rugby Fan Would Appreciate

To celebrate his major triumph, Mole treated his friends and family to a luxurious suite at Twickenham Stadium, the renowned home of England’s National Rugby team, where he enjoyed watching his beloved Motherland compete in the Six Nations Championship. He shares the moment at the 1:16:20 mark of the episode.

📈 Recent Deals

  • France-based company Physio-Assist is set to be acquired by Inogen, as the two companies have signed a definitive agreement valued at approximately $45 million. This strategic acquisition aims to strengthen Inogen’s respiratory product portfolio. Under the terms of the deal, Physio-Assist will receive around $32 million in cash from Inogen upon closing, along with additional payments tied to milestones associated with securing clearance from the Food and Drug Administration for the device.
  • Tadiran Telecom, an international provider of Advanced Unified Communications and Collaboration (UC&C) Solutions, has entered into a definitive agreement to be acquired by OMNIQ Corp. (NASDAQ: OMQS) (“OMNIQ” or “the Company”). Tadiran achieved revenue of $26 million in FY 2022, with $1.7 million in operating profit. In the acquisition deal, OMNIQ will pay a total of $15.25 million (around 9 times operating profit) for the complete acquisition of 100% of Tadiran.

If you know a founder who has successfully exited their business and has valuable insights to share, we encourage you to nominate them.  

This Week’s Contributors

Colin Morgan, Executive Producer of Built to Sell Radio, John Warrillow, Host of Built to Sell Radio, Daphne Parsekian, Copy Editor, and Denis Labataglia, Audio Engineer.

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