May be earn-outs aren’t quite so great just now

(By Richard Holway and Anthony Miller) As an adjunct to our ongoing 'Exit Strategies' debate, here's some food for thought about the pros and cons of earn-outs. I refer you to Clarity Commerce’s interim results statement today (see here). There’s an interesting comment regarding the company’s position on paying the earn-out for its acquisition of MATRA, now due, which I reproduce in full (with my emphasis):

In the Balance Sheet, deferred consideration of £4.1m (from both non current and current liabilities) relates to the MATRA earn out, which has now been crystallised and is payable via a combination of shares and cash. At the discretion of the Board, up to £1.8m may be settled at any time up to 30 September 2009 by the issue of Clarity shares, with the balance of £2.3m to be settled via loan notes over the next 3 years (of which, the first 12 months liability appears as "current"). Should the Board decide that the issue of equity is unattractive, it may elect to settle the equity component via additional loan notes, payable in monthly instalments, at the end of the initial loan notes term. Importantly, should the Board determine that it would be imprudent to pay out the monthly cash sums at any stage, it may suspend the monthly payments.

Readers should be aware that Loan Notes are only as secure as the organisations issuing them. If they are issued by the acquiring company without a bank guarantee and the acquirer goes bust, you will lose your loan notes. The same applies if the bank guaranteeing them goes bust (not unknown nowadays!) or if the insurance company insuring the debt defaults (also all too common) Back in the 1990s a friend of mine sold his company to a quoted SITS company and took over £1m of loan notes to mitigate CGT. A year later, the company went bust and he lost the lot. It made a huge effect on him and his family.

If you sell your company, which you've spent your lifetime building, take extra care to ensure that your hard earned reward is secure.