Explore the intricacies of earnout disputes in M&A deals with a focus on the Warren Hill, LLC v. SFR Equities, LLC case. Learn key takeaways and how to prevent similar conflicts.
M&A Stories
February 27, 2019
Introduction:
In the world of M&A, sellers often agree to earnouts as part of the purchase price, linking payments to future business performance. However, these arrangements can become contentious, as demonstrated in the case of Warren Hill, LLC v. SFR Equities, LLC, decided on February 8, 2019.
The Scenario:
In this case, the buyer acquired the seller’s interest in a limited liability company, with 50% of the purchase price tied to the company’s net income from 2016 to 2018.
The Lawsuit:
The seller sued the buyer in a Pennsylvania federal court, alleging underpayment of the 2016 and 2017 earnouts. One of the key disputes revolved around expenses paid to affiliates of the company, partly owned by the buyer. The court sided with the seller, stating that these fees should not have been considered expenses for earnout calculations.
Another contention was whether all of the company’s revenue was included in the net income calculation. The court ruled against the seller, emphasizing that revenue should align with what the company actually received.
Key Takeaway:
This case underscores the importance of a well-defined earnout formula in purchase agreements. To prevent such disputes, parties can consider fixed purchase prices, eliminating the need for later earnout battles. Alternatively, using a revenue-based formula can minimize disagreements over expenses.
Case Reference:
This case is referred to Warren Hill, LLC v. SFR Equities, LLC, Civil Action No. 18-1228, United States District Court, E.D. Pennsylvania, (February 8, 2019).
By John McCauley: I help businesses minimize risk when buying or selling a company.
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