{"id":21222,"date":"2019-11-12T22:52:52","date_gmt":"2019-11-13T03:52:52","guid":{"rendered":"https:\/\/breakingintowallstreet.com\/biws\/?post_type=biws_kb&#038;p=21222"},"modified":"2025-03-28T23:55:49","modified_gmt":"2025-03-29T04:55:49","slug":"earnout-accounting","status":"publish","type":"biws_kb","link":"https:\/\/breakingintowallstreet.com\/kb\/ma-and-merger-models\/earnout-accounting\/","title":{"rendered":"Earnout Accounting in M&#038;A Deals and Merger Models (21:49)"},"content":{"rendered":"<div id=\"ez-toc-container\" class=\"ez-toc-v2_0_81 counter-flat ez-toc-counter ez-toc-grey ez-toc-container-direction\">\n<div class=\"ez-toc-title-container\">\n<p class=\"ez-toc-title\" style=\"cursor:inherit\">Earnout Modeling in M&amp;A Deals and Merger Models<\/p>\n<span class=\"ez-toc-title-toggle\"><\/span><\/div>\n<nav><ul class='ez-toc-list ez-toc-list-level-1 ' ><li class='ez-toc-page-1'><a class=\"ez-toc-link ez-toc-heading-1\" href=\"https:\/\/breakingintowallstreet.com\/kb\/ma-and-merger-models\/earnout-accounting\/#Earnout_Accounting_What_Are_Earnouts_and_Why_Do_Companies_Use_Them\">Earnout Accounting: What Are Earnouts, and Why Do Companies Use Them?<\/a><\/li><li class='ez-toc-page-1'><a class=\"ez-toc-link ez-toc-heading-2\" href=\"https:\/\/breakingintowallstreet.com\/kb\/ma-and-merger-models\/earnout-accounting\/#Why_Use_an_Earnout_in_an_M_A_Deal\">Why Use an Earnout in an M&amp;A Deal?<\/a><\/li><li class='ez-toc-page-1'><a class=\"ez-toc-link ez-toc-heading-3\" href=\"https:\/\/breakingintowallstreet.com\/kb\/ma-and-merger-models\/earnout-accounting\/#Earnout_Accounting_on_the_Three_Financial_Statements\">Earnout Accounting on the Three Financial Statements<\/a><\/li><li class='ez-toc-page-1'><a class=\"ez-toc-link ez-toc-heading-4\" href=\"https:\/\/breakingintowallstreet.com\/kb\/ma-and-merger-models\/earnout-accounting\/#Earnout_Accounting_Purchase_Price_Allocation_and_Sources_Uses\">Earnout Accounting: Purchase Price Allocation and Sources &amp; Uses<\/a><\/li><li class='ez-toc-page-1'><a class=\"ez-toc-link ez-toc-heading-5\" href=\"https:\/\/breakingintowallstreet.com\/kb\/ma-and-merger-models\/earnout-accounting\/#Earnout_Accounting_on_the_IS_BS_and_CFS_in_a_Merger_Model\">Earnout Accounting on the IS, BS, and CFS in a Merger Model<\/a><\/li><\/ul><\/nav><\/div>\n\n<h2><span class=\"ez-toc-section\" id=\"Earnout_Accounting_What_Are_Earnouts_and_Why_Do_Companies_Use_Them\"><\/span>Earnout Accounting: What Are Earnouts, and Why Do Companies Use Them?<span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p>Instead of paying for a company 100% upfront, the buyer offers to pay some portion of the price later on \u2013 *if certain conditions are met.*<\/p>\n<p><strong>Example:<\/strong> \u201cWe\u2019ll pay you $100 million for your company now, and if you achieve EBITDA of $20 million in 2 years, we\u2019ll pay you an additional $50 million then.\u201d<\/p>\n<p>Earnouts are VERY common for private company \/ start-up acquisitions in tech, biotech, pharmaceuticals, and related \u201chigh-risk industries.\u201d<\/p>\n<p>EA acquired PopCap for $750 million upfront, and offered an earnout that varied based on PopCap Games\u2019 cumulative EBIT over the next 2 years. The schedule was as follows:<\/p>\n<ul>\n<li><strong>2-Year Earnings Under $91 Million:<\/strong> Nothing<\/li>\n<li><strong>2-Year Earnings Above $110 Million:<\/strong> $100 million<\/li>\n<li><strong>2-Year Earnings Above $200 Million:<\/strong> $175 million<\/li>\n<li><strong>2-Year Earnings Above $343 Million:<\/strong> $550 million<\/li>\n<\/ul>\n<div class='code-block code-block-9' style='margin: 8px 0; clear: both;'>\n<div class=\"kb-adinsert-modal\">\n    <div class=\"kb-adinsert-top\">\n      <div class=\"media\">\n          <img decoding=\"async\" class=\"alignnone size-full wp-image-28448\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/05\/22172829\/vc-tile.png\" alt=\"Venture Capital & Growth Equity Modeling\" width=\"128\" height=\"128\" \/>\n      <\/div>\n      <div class=\"content\">\n          <h3>Model and Value Startups, Understand Cap Tables, and Prepare for VC Interviews<\/h3>\n      <\/div>\n    <\/div>\n    \n    <div class=\"full_text\">\n    \t<ul>\n        \t<li>\n            \t<h4>Evaluate companies and deals like a pro<\/h4>\n              <p>You\u2019ll understand cap tables, startup\/growth valuations, and exits<\/p>\n\t\t\t    <\/li>\n          <li>\n          \t<h4>Master financial modeling<\/h4>\n            <p>You\u2019ll build forecasts and analyze metrics for tech and biotech startups<\/p>\n\t\t\t    <\/li>\n          <li>\n          \t<h4>Complete 9 case studies<\/h4>\n            <p>You\u2019ll learn the numbers and how to make investment recommendations\n\n<\/p>\n\t\t\t  <\/li>\n      <\/ul>\n        \n      <a class=\"cta-link orange-button-medium\" href=\"https:\/\/breakingintowallstreet.com\/venture-capital-modeling\/\" target=\"_blank\">Full Details<\/a>\n      \n      <a class=\"cta-link orange-button-medium bg-blue\" href=\"https:\/\/biws-support.s3.us-east-1.amazonaws.com\/Course-Outlines\/Venture-Capital-Modeling-Course-Outline.pdf\" target=\"_blank\" rel=\"noopener\">Short Outline<\/a>\n    <\/div>\n<\/div>\n<\/div>\n\n<style>.enteremail__large--inline{margin:60px auto!important}<\/style>\n<h2><span class=\"ez-toc-section\" id=\"Why_Use_an_Earnout_in_an_M_A_Deal\"><\/span>Why Use an Earnout in an M&amp;A Deal?<span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p>You see them most often when the buyer and the seller disagree on the seller\u2019s value or expected financial performance in the future.<\/p>\n<p>Earnouts are a way for the buyer and seller to compromise and say, \u201cWe don\u2019t really know how we\u2019ll perform in the future, but if we reach a target of $X in revenue or EBITDA, you\u2019ll pay us more for our company.\u201d<\/p>\n<p>The buyer will almost always want to base the earnout on the seller\u2019s standalone Net Income, while the seller prefers to base it on revenue, partially so the seller can spend a silly amount to reach these revenue targets.<\/p>\n<p>As a compromise, EBIT or EBITDA are sometimes used.<\/p>\n<h2><span class=\"ez-toc-section\" id=\"Earnout_Accounting_on_the_Three_Financial_Statements\"><\/span>Earnout Accounting on the Three Financial Statements<span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p><strong>Balance Sheet:<\/strong> Earnouts are recorded as \u201cContingent Consideration,\u201d a Liability on the L&amp;E side.<\/p>\n<p><strong>Income Statement:<\/strong> You record changes in the value of the Contingent Consideration here, i.e. if the probability of paying out the earn-out changes, you show it as a Loss or Gain here. It\u2019s a Loss if the probability of paying the earn-out increases, and a Gain if the probability decreases.<\/p>\n<p><strong>Cash Flow Statement:<\/strong> When the earn-out is paid out in cash to the seller, it\u2019s a cash outflow here. You also have to add back or subtract changes in the Contingent Consideration value here, reversing what is listed on the Income Statement.<\/p>\n<h2><span class=\"ez-toc-section\" id=\"Earnout_Accounting_Purchase_Price_Allocation_and_Sources_Uses\"><\/span>Earnout Accounting: Purchase Price Allocation and Sources &amp; Uses<span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p>Earnouts do not affect the Sources &amp; Uses schedule for the initial transaction since no cash is paid out yet.<\/p>\n<p>Earnouts *increase* the amount of Goodwill created in an M&amp;A deal because they boost the Liabilities side of the Balance Sheet, which, in turn, requires higher Goodwill on the Assets side to balance it.<\/p>\n<h2><span class=\"ez-toc-section\" id=\"Earnout_Accounting_on_the_IS_BS_and_CFS_in_a_Merger_Model\"><\/span>Earnout Accounting on the IS, BS, and CFS in a Merger Model<span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p>You tend to leave the Income Statement impact blank in a merger model unless you have detailed estimates for the seller\u2019s future performance.<\/p>\n<p>You SHOULD factor in the cash payout of the earnout on the combined Cash Flow Statement \u2013 you can assume a 100% chance of payout, or some lower probability.<\/p>\n<p>The payout will appear in Cash Flow from Financing and reduce cash flow and the company\u2019s cash balance.<\/p>\n","protected":false},"excerpt":{"rendered":"<p>In this tutorial, you\u2019ll learn how and why earn-outs are used in M&#038;A deals, how they appear on the 3 financial statements, and how they impact the transaction assumptions and combined financial statements in a merger model.<\/p>\n","protected":false},"featured_media":21888,"template":"","class_list":["post-21222","biws_kb","type-biws_kb","status-publish","has-post-thumbnail","hentry","kb_category-ma-and-merger-models"],"acf":[],"_links":{"self":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/biws_kb\/21222","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/biws_kb"}],"about":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/types\/biws_kb"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/media\/21888"}],"wp:attachment":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/media?parent=21222"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}