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Lessons from a Private Equity Earn Out: How I Lost £550K Due to a Lowercase 'C' The excitement and promise of an acquisition shouldn't be mired by the politics of a bad earn out agreement.

Edited by Jason Fell

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Written by Sam Oliver, a Scottish tech entrepreneur and serial startup founder. He's the CEO of London-based OpenFi.

In 2016, I founded my second software company, Lead.Pro—a tool that automated online bookings for property sale viewings in London. Estate agents, however, weren't keen on the idea. After struggling for a year and a half, my co-founder left, but I was determined to see it through.

Thankfully, we pivoted and found the product-market fit that led to scaling and profits, and we even acquired another startup. Then COVID hit, everything ground to a halt, and our savings dwindled.

Though we had interest from private equity buyers, they were reluctant to meet my price. Eventually, we compromised: the firm would meet my sale price through an earn out structure (briefly, in an earn out, a portion of the payment is made upfront, with the rest of the payment made contingent on specific performance targets). We agreed that half the sale would be paid upfront, and a year later the second half would be paid in proportion to certain growth terms. In short, if I performed, I'd get the full price.

The reality turned out to be more complicated. When calculating the final terms of the second payment, we disagreed on the number, eventually landing us in dispute resolution. There, I lost £550,000 due to a lowercase "c" in the contract being interpreted against me. And this is just one of several examples of how this deal turned into a disappointment.

In today's tough funding and exiting climate, it's likely there are a lot of founders out there who are considering similar offers. Here are the key learnings I wish I'd known before I signed the dotted line.

Lawyer up and push for protection.

Though I had bought and sold businesses previously, the details around this complicated sale structure and contract clauses were all new to me. I had also never worked directly with a private equity firm before.

It may sound obvious, but get a good, specialized attorney early in the process. I picked a generalist law firm through a recommendation. What I should have done was run a formal recruitment process and chosen a firm that specialized in mergers and acquisitions.

With the right legal representation, you will be better equipped to push for the most appropriate protective clauses. In my case, a board member suggested we: 1) calculate earnings at the end of every month and 2) keep our IP in escrow until after the final payment. While we included the first, we left out the second. This was a regretful decision that I'll explain later, but the reason I didn't push for the second condition was my novice fear of losing the sale. A lawyer specialized in M&A would have known this was a worthy risk.

An expert M&A lawyer can also protect you from badly composed clauses. In my case, the contract stated that any revenue must not have involvement with "connected parties." This was meant to protect the buyers from any shady business dealings. I was fine with this and disclosed that two of my shareholders also worked at companies that were customers—both of whom testified in writing they were uninvolved in the dealmaking.

Once we went to dispute resolution, however, the third-party accountant deemed the revenue from those two contracts invalid. Hence my losing £550,000 due to a lowercase "c." Had the "C" in "connected parties" been capitalized, it would have fallen under the HMRC Taxation of Chargeable Gains Act, which in the UK formally defines a Connected Party as a person who has control of a company, which was not the case with either of my shareholders.

May you learn from my mistakes: seek out the right lawyer for the job who can advise for, demand, and defend the most appropriate protective clauses.

The 100-day plan starts when the earn out ends.

Whenever a smaller business is acquired, the larger business puts together a 100-day plan that lays out how the two businesses will integrate. In our case, day one began after the initial trade sale payment. So while I was still the CEO of my own business, I was also the CPO for the company that bought us. From this position, I felt obliged to do right by both parties, especially as I assumed I would continue working as the CPO beyond the one-year deal.

If I could do it again, I would demand our IP go into escrow and that we not begin integration until after the final earn out payment. This would have shielded me from the situations which were clearly a conflict of interests between my business and theirs, while also giving me more leverage and political safety to push back when I felt pressured to do things that in the end wasted time and opportunities.

For example, as a show of good faith that we were now within the larger organization, we handed over financial management to the larger department (something we lost additional time undoing when it was clear things were being mismanaged) and tried integrating our CRMs. I also naively stopped holding regular board meetings with our original shareholders.

Though I knew these things didn't necessarily benefit my team, I assumed the goodwill of quickly assimilating would be extended back to me. In the end my goodwill was not returned – on top of the dispute resolution I was also made redundant after the year was up – and the time lost could have been spent doubling our earnings by bringing in new revenue.

Should you find yourself drawing up the contract for an earn out, draw a firm line in the sand between your business and that of your buyer. By delaying integration, putting your IP in escrow, and continuing to hold board meetings until after the earn out is complete, you'll create a boundary that allows you to focus on your main priority—whatever is in the best interest of your business.

Keep your POV short term.

I spent years building my company from the ground up, at one point even remortgaging my house to keep it afloat before we found product market fit. Like many founders, I developed an emotional attachment—I cared about it. And because I cared, I initially spent too much time at the start of the contract year with the product, improving old bits of code and releasing new features.

Thankfully, a mentor snapped me out of it. What I learned is that when you agree to an earn out, you've got to reframe the way you think about your company. First of all, it's technically no longer yours, and that alone can be difficult to wrap your head around. But more importantly, the long term vision is no longer under your jurisdiction.

If I could relive that year, I'd focus exclusively on the growth terms laid out in the contract, which were based entirely on increasing revenue. Not only would that have meant not worrying about product improvement, but I also would have made smarter strategic decisions. For example, I had the opportunity to buy another company that would have increased monthly recurring revenue by £6,700 and added £241,200 to the final earn out payment.

Unsurprisingly, I was discouraged from completing the deal and even warned that if I did there would be negative consequences. Wanting to prioritize our long-term relationship, I didn't go through with it, but that was a mistake. From the moment you sign an earn out contract, you should be heads down on whatever is going to get you the greatest pay out.

While founding a startup is never an easy path to take, the excitement and promise of an acquisition shouldn't be mired by the politics of a bad earn out agreement. I hope offering these lessons learned can help make it a bit easier for fellow entrepreneurs who may be faced with a similar situation.

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