How to Respond to the Most Common Emotional Blackmail When an Earn-Out Is Involved

“If you distrust us that much, maybe it doesn’t make sense to continue.”

I don’t know how many times I’ve heard a buyer use this argument, addressing the seller directly, in the middle of heated negotiations over the share purchase agreement (SPA) in an M&A transaction.

It’s emotional blackmail. Nothing more. Fortunately, it’s easy to rebut—but it’s important to do so in the right way so as not to further strain the negotiation.

So where does the conflict typically come from?

In many of the deals we advise on, part of the price is structured as an earn-out. Typically, a deferred payment tied to specific targets: achieving certain EBITDA, ARR, sales figures, or a combination of several KPIs over the next few years.

The problem is that these targets have to be achieved once control of the company has already been lost, when execution is, by definition, no longer straightforward.

Our client, the seller, starts thinking about all the things the buyer could do, if acting in bad faith, to avoid paying this deferred consideration, and tries to protect against all of these scenarios in the contract.

For example: allocating group corporate costs to the company, shifting revenues to another group entity, changing accounting policies, moving key employees to other business units within the group, increasing costs that may be positive in the long term but erode EBITDA in the short term, dismissing the founder so they no longer have visibility into how the company is run and cannot prioritize achieving the earn-out targets…

The question is how to put all of these bad-faith scenarios on the table without the other party—the buyer—becoming indignant (or pretending to be indignant, because as you know, there’s often quite a bit of theater in M&A).

My suggestion is always the same: be careful with language and depersonalize.

Never say something like: “What I want is a three-year lock-in as CEO to prevent you, for example, from firing me in year three—which is when the earn-out is measured—and then loading the company with expenses that benefit you in year four and reduce EBITDA so you don’t have to pay me the earn-out.”

Yes, it’s true—this is exactly what we’re thinking and what we want to protect against. But directly accusing the other side of potentially being despicable people is not the best way to reach an agreement, nor the best way to relate to the people who will be the owners of your company and your bosses going forward.

The right way to address this point is different: “What we’re trying to cover are scenarios that could occur even if nobody wants them to. Imagine that tomorrow you’re no longer in charge because there’s a change of control, and the new management disagrees with the acquisition you made and decides it doesn’t want to pay the earn-out. Then they fire me…”

The key point is not to accuse individuals directly, to depersonalize the issue, and to refer to the fact that the contract is signed with a company—and in companies, the people in charge sometimes change.

It’s not a matter of personal trust. I trust you one hundred percent. It’s about making sure the agreement survives the passage of time.

In my experience, the counterargument I’ve often heard in response to this way of dismantling the emotional blackmail of “if you distrust us that much, maybe it doesn’t make sense to continue” goes something like this: “This is a family business and we’ve been in charge for three generations. There’s no reason to think we won’t still be here in three years.”

Or: “I’ve signed an agreement with a private equity fund and it’s a five-year project that’s already invested. Do you really think I’m going anywhere?” “I’ve been running this company for fifteen years; there’s no reason not to be here in three more. Besides, it’s my team and my culture—nothing would change even if I weren’t.”

At this point, it’s important to return to the same core idea. As a seller, you’re signing with a company, not with a person. Most likely, they will indeed still be in charge in three years—no doubt about it. But: “Contracts are there to protect against the unusual things that can happen. In fact, the normal situation is that you never have to look at the contract again.”

“I trust you and I’m sure you’ll stay, but sometimes things happen: an industry or country crisis, a financial crisis that leads to a change of control, a serious illness, or even a death (I can’t help it—I love slipping a bit of dark humor into negotiations).”

When you manage to insist that this is not about a lack of trust in people, but about the fact that companies are not people, the argument is defused and everyone goes back to the negotiating table.

The moment to land the negotiation

That said, it’s important not to lose sight of a basic reality of M&A.

It’s also true that when you sell a company, you can’t protect against every possible scenario. If you’ve sold control of a company for twenty million euros, even if another ten million are tied to an earn-out, you have to accept that the buyer has paid for control. The goal is to find a middle ground where the interests of both parties are reasonably protected.

As I always say, a good deal is one that is sufficiently satisfactory for all parties, but doesn’t leave anyone completely comfortable. Each party assumes certain risks, but understands that what it receives in return is enough to compensate for them

By Joshua Novick, partner at Bondo Advisors

Source: https://www.joshuanovick.com/p/si-desconfias-tanto-de-nosotros-igual