Thus, all earnings are retained in the business during the term of the earnout or, if distributed from the business, the business is credited with a return on capital consistent with the projections upon which the earnout was based. Another approach is to provide that capital needs of the target business will be evaluated on a basis consistent with the acquiror's corporate policy and contributions to the target's business will be charged at the acquiror's cost of capital rate charged generally to competing divisions. The list of possibilities is limited only by the creativity of the parties to the transaction and the internal operations of the businesses at issue. Overhead Another major issue to address in drafting a workable earnout provision is the allocation of overhead to the target's business. This is another of those traps for the unwary.
Overhead costs can represent a staggering percentage of earnings.
Methods to consider in containing this element of the equation include specifying the individual items that can be charged against the target's business. At this point the simple approach generally will prevail. But beware, you must still identify the elements to be included in overhead lest you awake to find that the cost of regional sales management is a separately listed charge not included in general corporate overhead. In addition to these fundamentals, the duration of the earnout must be determined. Generally, the longer the earnout the lower the risk to the buyer and the greater the potential reward to the seller.