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O que é earnout? Em que tipo de operação de M&A é utilizado? Como ele é negociado? - YouTube
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Hi, I'm Luciana Renouard and this is Madrona Talks.
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Today we're going to talk to Ricardo Madrona, our M&A partner, about earnout.
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Ricardo, what is earnout and in what type of M&A transaction is it used for?
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Earnout is a structure widely used to buy and sell companies and
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consolidations both.
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It serves to enable a transaction when there is a divergence in price.
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The buyer has an expectation of how much the business is worth and the seller has
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another one.
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So this mechanism was created to resolve this situation.
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How do you do it?
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It establishes a part of the price to be paid in cash and another part is subject to the result of
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the company's performance in the future.
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Earnout is nothing more than a way of structuring the price in an M&A transaction.
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In general, how is it negotiated and how do we calculate earnout?
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Earnout is negotiated when questions about valuation arise.
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The performance issue will equalize how you will value the asset
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to reflect the appropriate price.
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Performance metrics vary.
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You can use EBITDA, the most common one to set a price to the asset, but I've seen others,
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such as net revenue, sales targets.
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Since it is a mechanism to structure and put buyer and seller interests
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on the same footing, the metrics can be several.
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What is common is, if the price is set in EBITDA multiples, that earnout
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be also set in EBITDA multiples.
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But it's not necessarily the only rule.
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Earnout is not in the legislation.
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It came out of the result of M&A negotiations in the market.
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It allows for a lot of flexibility to structure the metrics.
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Depending on what is to be used to set a price for the company's performance in the future
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after the acquisition is closed, there may be a greater or lesser risk of earnout actually
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happening.
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Usually, when you sell the company, you lose a little of the control over
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the company's activities.
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How does this affect earnout and what is the difference between those selling 100%,
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and those who remain as minority partners?
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Does this affect earnout, the negotiation?
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That's a good point.
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I think that one of the major difficulties is that if you sell 100%,
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and having earnout or not depends on the performance of the company, you are delegating to the buyer,
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who will manage the business, that it permits performance to happen or not.
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So you're transferring a part of the price, the risk, to the buyer.
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When you have a transaction that is not total, if you sell a minority stake,
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the risk is lower because you are in control of the company's management.
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If you are selling a majority stake and you have become a minority partner,
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you’re not at 100% risk nor in control of the business.
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It is very common in transactions that have earnout as a component that this risk
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be appropriately allocated in the agreement.
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If you leave 100%, the guarantees are contractual.
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You have to establish what the buyer may or may not do, and what deviations may occur
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during the metric - the measurement of performance - should be excluded from the earnout calculation.
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If you become a minority shareholder, you create protective vetoes, for example in the
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shareholders' agreement.
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If you have EBITDA as a metric, you can establish that some expenses
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be excluded from the calculation.
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It is very common that in a family business, for example, which does not have an audit and that
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does not have an ERP system – which is expensive – and an international buyer that will increase
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the cost of the company, that you exclude it.
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In earnout, these components cannot be included when determining the EBITDA
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of the company during that period.
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It makes a lot of difference whether you sell 100% or not and the seller manages to have some way
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of controlling the performance of the asset being sold.
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Although we see in most M&A deals earnout linked to EBITDA's performance,
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we should think of other metrics in order to defend the seller
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a little more.
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You're thinking like a seller.
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With EBITDA, there are many risks as expense of the company.
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If it's a leveraged company, you have the issue of interest.
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If you have another simpler metric to find, upon which the seller has more control,
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it's safer for him.
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But it is very difficult to establish a different criterion than the one used to set the price
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of the company.
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Because earnout is price, you have two metrics to set the price of that asset.
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The most common is that if valuation, the price of the company, was set in multiples of EBITDA,
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that the earnout is also made in multiples of EBITDA.
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It's possible, but I find it rather difficult.
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Based on my experience, I haven't been able to give that kind of protection much.
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It is more common to create protections for the seller in a meeting currently.
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Vetoes, exclusions from expenditure, than actually having... if not, you'll end up with apples and oranges,
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two absolutely different things.
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You just told me earnout is price.
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How is earnout taxed?
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Same way price is.
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The difference is that the price in cash is assessed at the time it is received, according
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to the tax rules, and taxes are paid within a period.
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The tax is normally due on the last day of the month following the transaction.
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As earnout is a contingent price, it can happen or not --
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in full or not -- you leave it to be assessed later.
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The moment it becomes due, that's when taxation happens.
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You'll treat it as price.
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If the recipient is an individual, the methodology to assess capital gain is
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cash-based.
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If it is a legal entity, it is not cash; from the moment it became due
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and there is a defined date, it creates the taxable event for the tax to be paid.
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The tax rate is the same, it is only a matter of tax payment
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being deferred.
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When you are the buyer, you have 1 year to account for
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the price you paid.
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What is it like for the buyer if earnout is assessed after a year?
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The buyer, while earnout is not determined, has no way of accounting for it.
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The most common sitaution is to have a 2 to 3 year earnout.
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It is never 1 year – I, for example, have never seen a 1-year earnout - it has a
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longer term.
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Here we also have a risk issue.
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If we have a 3-year earnout, a seller is exposed to 3 years, not only the risk of the company's
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performance, but of the market in which it is inserted – macroeconomic risks.
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From the point of view of the accountant, until price is determined, it is only a contingent
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issue: I cannot even set a price.
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From an accounting point of view, and I'm not an accountant, I'm a lawyer, you can't even
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set a price for accounting purposes.
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What you will probably have are explanatory notes in the financial statements
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saying that there is a risk of payment.
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An important fiscal issue today in Brazil is that if you make an acquisition at a premium,
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you may have some tax benefit from deducting a premium, and you cannot
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determine the premium based on earnout while its price is not set.
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First, you have to decide if it's due and how much is due.
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Only then do I think it will generate accounting impacts on the company.
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In your experience, is this a clause that brings much discussion between the parties?
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If it does, who is better prepared to deal with this kind of issue:
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arbitration or the Judiciary?
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I think it is one of the clauses that brings more discussion and the discussions are varied.
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As I said before, as it has risk performance components, how
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the buyer manages the company after it is acquired and the seller always
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has an expectation of realization of earnout, frustration leads to this kind of discussion
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on how to quantify earnout and whether it will become due.
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There are lots of discussions, for sure.
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How much this is taken to the Judiciary or to arbitration, we don't know
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because for in this type of transaction it is very common to have an arbitration clause and not one
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for the Judiciary, and we don't have arbitration case law.
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There is no way to know how much it happens, how often, I think that in terms
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of choice, that is one of your questions, I prefer arbitration over the Judiciary, because
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it is a discussion that does not involve legal concepts, but accounting, economic, management
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elements.
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There is an important legal issue which is liability.
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Who is liable for the performance and the contract is instrumental.
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To me, it is the biggest legal issue that is subject to discussion.
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Arbitration provides a more appropriate panel for this type of issue.
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If it involves accounting, one can choose an arbitrator who is trained as an accountant.
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If the discussion has more to do with civil liability, one chooses a lawyer as an arbitrator.
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I prefer arbitration not only because the subject matter is very technical, not necessarily legal,
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but because I can choose people who can judge the object of the dispute more appropriately.
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Ricardo Madrona, thank you so much for being here.
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It was my pleasure to be here with you.
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Next week, we'll be back with another conversation here at Madrona Talks.
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