Decline in Earnouts May Signal Less Risky M&A Environment

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As volatility roils equity markets, one gauge of executives’ confidence about future deals has come to light in a recent industry study. Contingent deal payments, or earnouts, appeared in a declining number of mergers last year for the first time since 2018. In fact, according to study recently published by SRS Acquiom, they dwindled to pre-pandemic levels as a percentage of profit.  

The study, which tracked 1,900 transactions that closed between 2016 and 2021 with a total deal valuation of over $425 billion, found the median earnout constituted 31 percent of total deal consideration in 2021, down from 38 percent the previous year.

One read of this decline is that they’re less needed to temper high deal valuations. Private sector deal valuations are forecast to fall in the wake of rising interest rates and general volatility that the markets are enduring in 2022, though this effect has yet to fully felt. Firms from Carlyle to Apollo report rising portfolio valuations even as high deal multiples make it difficult to replicate pre-pandemic gains. But perhaps a slowing rate of earnouts in M&A contracts simply speaks to buyers’ sensitivity to changing winds, suggesting they will become less likely to hedge the future success of target earnings by offering earnouts.

There’s also a more straightforward takeaway: pandemic-related risks that drove earnouts higher could be receding from dealmakers’ minds. Grant Thornton’s national managing principal for M&A Elliot Findlay recently told Mergers & Acquisitions that labor shortages and supply chain issues were also behind these contingent pay structures; reducing earnout activity could imply more business confidence that these factors are also expected to abate.

Brandon Zero



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