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M&A Target Companies Must Ensure Consistent Management

The sharp rise in Mergers and Acquisitions (M&A) transactions has been dominating headlines. The financial markets have shown strong increases with reports of over $3 trillion in global deal-making in 2014 – $1.5 trillion of which has targeted American companies. The large, multi-billion dollar acquisitions have received lots of attention. However, the general upswing is affecting several markets — most notably healthcare, technology, and media industries – and can benefit smaller companies too. The conditions are ideal for this increased M&A activity. Recent months have seen steadily low borrowing costs as well as rising share prices. There is a sense of relative stability in the market which has led companies to consider, and aggressively pursue, M&A transactions.

When considering any M&A transaction, it is vitally important for companies – especially smaller target companies – to be prepared and knowledgeable. Seemingly minor phrasing in purchase agreements can have significant implications for the acquired company. One area of particular importance is how the target company will be compensated. A commonly used tool for payment is escrow. However, an increasingly common, and less understood, tool is an earnout. Earnout provisions are contingent on the future performance of the targeted company. The shareholders or target company only receive a segment of the consideration – up to 50% of the purchase price – if certain milestones are met over a designated time.

Since earnouts are contingent on performance, management is crucial. Poor management, or even intentional manipulation, may deprive the target company and/or its shareholders of a considerable amount of the purchase price. Target companies should ensure that old management remains after the sale to ensure consistent operations. At the Gellis Law Group, we have the knowledge and experience to protect target companies from potentially detrimental situations, such as a poorly construed earnout clauses in merger agreements.