Buy-sell Earnouts, Litigation, and the Changing Landscape

On May 12, 2020 GeekWire reported Seattle company Porch is being sued by Kandela, a company Porch acquired in April 2019. The basis of the lawsuit is Porch did all they could to stunt Kandela’s growth and profitability in order to avoid paying an earnout. If you’re not familiar with an earnout, it’s similar to a salesperson’s commission in that payment is based on performance.  

The Porch lawsuit alleges they (and this is from GeekWire), “have engaged in a stunning and systematic pattern of fraud designed to prevent Kandela from achieving any earnout” for hitting certain milestones, according to the complaint. They went on to say Porch withheld resources, refused to sell Kandela products (to Porch’s customers), and more. 

It’s why lawyers will joke and say the only winners with an earnout are the litigators. That said, in our pandemic world, everybody I’ve heard from believes earnouts will be more prevalent. And as much as I don’t like them, other than for special circumstances, I agree with this and have a business buyer client making an offer with a significant earnout component as the business has been hurt by the pandemic, and nobody knows how fast it will come back or at what level.

My advice to my client was: 

  • Keep it simple.
  • Make sure the seller can easily get to and see how he can get his full price.
  • Emphasize your goal to make the recovery as fast as possible (it’s in the buyer’s best interest anyway).

There are a lot of people out there who think there will be “deals” on business acquisitions. There will be on damaged companies (a deal meaning a lower price albeit for a company with less profit), there won’t be on solid companies, and earnouts will play a part in more deals than before (as will more seller financing). The objective is to have it be fair to both sides and be easy to figure out.

“Don’t gamble; take all your savings and buy some good stock and hold it till it goes up, then sell it. If it don’t go up, don’t buy it.” Will Rogers

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