How Should Sellers Tie Employees to the Earnout?

If a meaningful portion of your purchase price is allocated to an earnout, one major question is how to ensure that your employees are incentivized to help you achieve it.

One of the best methods is to find a Buyer who is willing to provide equity awards to your employees, as we saw in a trio of recently-announced acquisitions by Ondas Inc. (Nasdaq: ONDS). Ondas disclosed that it issued 37 separate awards to Seller employees, mainly RSUs and options. Most notably, the awards were time-based, with quarterly or monthly vesting over the next 2 years, largely coinciding with the 2-year earnouts in the 3 deals. This is potentially a massive boon to the Sellers.

In a deal where the Sellers are owner/operators who will stay in the business, those Sellers can retain meaningful control over the post-closing business and work toward the achievement of the earnout metrics. But, in situations where Sellers are not staying with the Target or joining Buyer, such as in a divestiture or platform sale, you are confronted with a divergence of interests: Seller's goals in achieving the earnout vs. the post-closing goals of the employees who will actually be running the business. Perhaps your earnout is based on net revenue or net income, whereas the employees are being incentivized to hit sales or revenue numbers. Or they may not survive the integration at all.

A Seller can tie-in those employees by signing letters at closing allocating a percentage of the earnout (e.g., 10%) to the employees. Or it can ensure that the employees' bonus and compensation packages are structured to harmonize with the earnout. But a separate tool, as we see in the Ondas transactions, is the Buyer equity package.

For Buyers, it may seem onerous considering that equity-based compensation is diluting your cap table, and is coming out of your pocket, rather than Seller's pocket. Yet, it sends a strong signal to Sellers that can help you win the deal. It potentially sends an even stronger signal to the employees that you want to integrate them into the long-term future of your business, perhaps extending the time horizon beyond the end of the earnout.

Sellers need every tool available to help achieve the earnout. Sellers who will not be part of the post-closing operations are particularly dependent on the efforts of the employees who are, truthfully, unlikely to care whether the Seller achieves the earnout. If your employees are disconnected from your earnout, their loyalty will be to themselves and their new employer, which could be the difference between a successful earnout and a failed one.

-Keith Bova