A variable price in the acquisition contract – watch out for requalification and manipulation

Acquisition agreements may provide for either a fixed or a variable price. A variable price is valid only if it can be determined. Hence the parameters that serve as the basis for establishing the variable price must constitute objective criteria that do not require a new indication of intent from the parties. Acquisition agreements often contain an earn-out clause: (part of) the price is determined based on the profit earned by the company in the years following the acquisition. Usage of the earn-out clause is most common when the selling party retains an important role in the management of the company after the takeover. The prospect of a possible price increase will motivate the seller to continue his/her task with diligence.

However, the seller must make sure that the earn-out clause is not qualified as a management fee. Gains on shares are exempt from tax for natural persons whose actions are non-speculative. Requalification as a management fee would make them taxable at the progressive income tax rate. For this reason the acquisition agreement had better avoid too many links between the earn-out clause and the management role of the seller after the takeover. The absence of separate competitive remuneration – i.e. in addition to the earn-out – for a seller who continues to perform tasks for the company, enhances the risk of requalification.

Furthermore, the seller of the shares must watch out for manipulation of the earn-out clause by the buyer: there is always a risk that the buyer starts taking certain operational decisions to influence the earn-out clause. Examples of such decisions include accelerated depreciation of fixed assets; excessive expenditure during the years on which the earn-out is based; taking large provisions, etc. The seller must make sure that the acquisition agreement minimizes the buyer’s control of elements on which the earn-out amount will be based. This could be covered by agreeing that the accounting rules (such as valuation and depreciation rules) must be applied in consistence with the past or in accordance with what has been agreed explicitly between seller and buyer in the contract. Another option is to stipulate that the calculation of the earn-out will disregard exceptional costs or income. Finally, a clause could be added stating that only the costs included in the business plan (attached to the acquisition agreement) or that have the explicit approval of the seller, may affect the earn-out.

Anneleen Steeno, intui law firm