sEarnout(22p) - Structuring and valuing incentive payments...

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Structuring and valuing Earnouts and other contingent payments Based on Notes by Robert Bruner
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Explore the effect of Incentive payments in future performance of target. Key point is fixed payment versus incentive contracts. Incentive payment schemes are options So, the correct way to value them is as an option approach Conceptually incorrect (and implies an arbitrage) to value earnouts as the expected value of the most likely scenario Earnouts are challenging aspect of the deal to structure. Incentives often allow a way to break negotiation deadlocks.
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Remember ‘Currency’ for M&A transactions?
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Bonus payments to sellers (esp. if managers of target) Escrowed funds: Part of total payment set aside for meeting target NPI Holdback allowance Part of total payment w/h at closing and paid on satisfaction of a condition Stock options X is usually set well above S Partially this reflects synergy. Earnout plan More complex measures of triggers
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Recent earnout examples Seagate Technology -> Quinta Corp (1998) Seagate paid Quinta $230m at closing and potential of $95m over the next 3 years - contingent on performance targets. Unocal Divestiture of 76 Products Co. to TOSCO (12/96) $2.05B in cash, c/s and earnout HFS -> Resort Condominiums (11/96) $550m cash, $75m c/s and earnout worth $200m. Rouse -> Hughes Corp (6/96) $176m combination stock and earnout
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Earnouts % of Payment Year Total Value % All deals # % All Deals due to earnout 1985 447 0.4% 8 1.3% 51 1986 2,082 0.9% 15 1.2% 26 1987 1,697 0.9% 15 1.1% 44 1988 1,795 0.7% 26 1.5% 54 1989 2,775 0.9% 52 2.4% 24 1990 1,439 0.8% 53 2.6% 21 1991 2,254 1.8% 55 2.8% 30 1992 1,273 1.1% 61 2.7% 40 1993 4,322
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This note was uploaded on 04/02/2009 for the course DEPARTMENT FIN 4320 taught by Professor Sherwoodbishop during the Spring '08 term at Southwestern.

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sEarnout(22p) - Structuring and valuing incentive payments...

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