Meaning
Performance metrics used in a corporate acquisition adjust the final transaction price based on the achievement of financial goals. The valuation adjustment model aligns the expectations of the buyer and the seller when there is a gap in the perceived value of the business. It sets specific financial targets such as net profit or revenue growth that must be met over a defined period.
Formulaic Adjustment
Payments are increased or decreased based on the degree to which the target entity achieves its projected milestones. If the audited accounts show that the firm exceeded its goals, the valuation adjustment model triggers an additional cash payment or the issuance of more shares to the seller. Conversely, a failure to meet the minimum thresholds results in a refund of part of the initial consideration to the buyer.
Enforcement Conflict
Disputes often arise over the accounting methods used to calculate the performance metrics during the earn-out period. To minimize friction, a valuation adjustment model should specify the exact accounting standards and the identity of the independent auditor responsible for the final tally. Clear definitions of what constitutes an extraordinary expense prevent either party from manipulating the net profit figure.
Strategic Purpose
This tool is common in high-growth sectors. It incentivizes the team.
