Risk Mitigation with Contingent Earnouts in M&A: Review of 2022

Abstract

Acquirers in mergers and acquisitions (M&A) use contingent consideration, i.e., price protection and adjustment mechanisms, as a tool to manage post-closing risks with respect to the price offered for acquiring a target firm. The earnouts are deferred-contingent payments of the offer price based on the achievement of a target company’s post-acquisition performance with respect to certain benchmarks based on future revenue or earnings. Such contingent payouts mitigate risks due to adverse selection and facilitate the transfer of the risk of overpayment from the acquirer to the seller (Kohers and Ang 2000; Caselli, Gatti, and Visconti 2006; Cain, Denis, and Denis 2011). For the sellers, such contractual mechanisms mitigate the risk of underpayment as they get additional payouts if their performance exceeds the contracted benchmarks. When acquirer and target firms differ in their assessment of fair value, such payouts also enable faster deal completion as part of the offer price is deferred and is to be paid on the achievement of some future performance target (Kohers and Ang 2000). For instance, in June 2022, Mondelez International Inc. announced the acquisition of energy bars manufacturer Cliff Bar & Co. for an upfront payment of USD 2.9 billion and a deferred payment of up to USD 2.4 billion if some profit-related targets are achieved in the future. This transaction is noteworthy, as the potential value of earnouts is over 45 percent of the initial offer price paid in cash. In another instance, in May 2022, the UK-based GSK Plc. announced the acquisition of the US-based bio-pharmaceutical company Affinivax Inc., whose key product is in the clinical stage, for an upfront cash payment of USD 2.1 billion. As reported by Refinitiv Eikon, Affinivax shareholders would receive earnouts up to USD 1.2 billion if the target achieves certain clinical development milestones in the future.