The Downside of Earnouts

question 34

Essay

The Downside of Earnouts
In the mid-1980s, a well-known aerospace conglomerate acquired a high-growth systems integration company by paying a huge multiple of earnings. The purchase price ultimately could become much larger if certain earnout objectives, including both sales and earnings targets, were achieved during the 4 years following closing. However, the buyer's business plan assumed close cooperation between the two firms, despite holding the system integrator as a wholly owned but largely autonomous subsidiary. The dramatic difference in the cultures of the two firms was a major impediment to building trust and achieving the cooperation necessary to make the acquisition successful. Years of squabbling over policies and practices tended to delay the development and implementation of new systems. The absence of new systems made it difficult to gain market share. Moreover, because the earnout objectives were partially defined in terms of revenue growth, many of the new customer contracts added substantial amounts of revenue but could not be completed profitably under the terms of these contracts. The buyer was slow to introduce new management into its wholly owned subsidiary for fear of violating the earnout agreement. Finally, market conditions changed, and what had been the acquired company's unique set of skills became commonplace. Eventually, the aerospace company wrote off most of the purchase price and merged the remaining assets of the acquired company into one of its other product lines after the earnout agreement expired.
-In your opinion, are earnouts more appropriate for firms in certain types of industries than for others? If so, give examples. Explain your answer.

Grasp the foundational concepts of various economic schools of thought including Keynesian, classical, and monetarist theories.

Identify the historical periods during which different economic theories were dominant.

Recognize the role of government policy in economic theory, particularly in response to recessions and inflation.

Understand the significance of investment according to Keynesian economics.

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