Earnouts sometimes seem like great ways for buyers and sellers to achieve common goals. Buyers mitigate acquisition risk, and sellers get all or some of their capital back (possibly with some initial return) and are relieved of future funding responsibilities. A crucial difference between a merger and other types of collaborations, such as strategic partnerships, however, is that the selling shareholders no longer have a company and may not have a management team inside the larger corporation to advocate for the program or to control its progress.
In some cases, the management team of the seller may join the buyer and continue to drive the development with the support that they need. In other cases, managers might move on to other projects or new companies. Regardless, selling shareholders seeking the earnout payments may not have the information and influence they were accustomed to receiving with an independent company and management team.
Selling shareholders will often seek out the former management and employees of the target company to keep an ear on the buyer’s progress towards meeting earnout milestones. When these resources work for the buyer, shareholders should be mindful of the employee’s confidentiality obligations to their employer. Buyers may assert that the employee is bound by confidentiality agreements, and the shareholders may be putting the employee at legal risk by asking questions related to confidential or proprietary information. In addition, buyers may assert that the selling shareholders are interfering with the management of the company they purchased. To resolve these issues, SRS Acquiom believes making it clear in the information rights section of the merger agreement that access to employees (whether former or current) is expressly permitted to the stockholders and their representative for the purpose of evaluating any earnout and claim provisions of the agreement.
In the end, sellers face many of the same challenges they do with other types of partnerships—they must successfully navigate the internal relationships, politics, and various strategic motivations of their large company partner to get their product approved and to market. Once their startup is acquired, however, the mechanisms, tactics, and people necessary to do so change.
Successful relationship management in a merger begins with selecting the acquirer. Savvy investors may favor an acquirer that has a genuine interest in retaining key members of seller’s management who are likely to have ongoing professional and financial interests in seeing the acquired programs succeed. In negotiating the earnout terms, it is advisable to select M&A attorneys who have expertise in negotiating milestone provisions of mergers or corporate partnering agreements. Investors should make sure that the shareholder representative they select has the mission, time, resources and expertise to manage effectively the ongoing relationship with the acquirer.