Structuring and Valuing Incentive Payments in M&A: Earnouts and Other Contingent Payments to the Seller
21 Pages Posted: 21 Oct 2008
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Structuring and Valuing Incentive Payments in M&A: Earnouts and Other Contingent Payments to the Seller
Abstract
This technical note introduces students to the use of earnouts and other forms of incentive payments in the context of mergers and acquisitions. The note describes the use of incentive payments in M&A, recent deals in which earnouts were used, the trend and volume of earnout deals, the benefits and disadvantages of earnout structures. The large concept in the evaluation of earnouts is their similarity to call options. This conceptual approach provides the foundation for considering how an earnout might best be structured, and how its value might be estimated. The note concludes with a generic valuation example and refers the reader to a spreadsheet model that might serve as a template for future assessments of earnouts.
Excerpt
UVA-F-1322
Rev. Feb. 11, 2014
STRUCTURING AND VALUING INCENTIVE PAYMENTS IN M&A:
EARNOUTS AND OTHER CONTINGENT PAYMENTS TO THE SELLER
Betting isn't always risky. In some cases, it actually reduces risk by sharing it among two or more parties.
—Bazerman and Gillespie (1999)
. . .
Keywords: investment analysis, earnout, mergers & acquisitions, incentive payment, Monte Carlo simulation
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