Eugene 💳🤖

Poppi's founders just learned the most expensive lesson in M&A! When they sold to PepsiCo, the deal was for $1.9B plus a $300M earnout (a future contingent payment based on the performance of the brand for some period after closing). And PepsiCo just announced that it is valuing that $300M at a “paltry” $12M. That stings! I've negotiated a lot of earnouts in my career. Here's what most sellers don't understand until it's too late: 1. An earnout is a future bet on a business you no longer control. After closing, the buyer sets budget, pricing, hiring, marketing, etc. Every lever behind whether or not you get your earnout belongs to someone else. 2. The incentives can flip the day you close if you’re not careful. As a seller, you want to do everything to hit the targets. But as the buyer, you pay less if they're missed. Ideally, the earnout is structured so that both parties win or lose together. If performance tanks, the buyer earns less overall so it pays less to the seller. If performance improves, the buyer earns more so it pays more to the seller. Incentives are aligned. What you absolutely cannot allow to happen is an earnout structured so that performance can improve allowing the buyer to earn more, but still pay less to the seller. How on earth could that happen? I'm so glad you asked... 3. The accounting decides the outcome. How you define "revenue", "EBITDA" or any other measurement metric used to determine the earnout is what ultimately drives the payout. So things like how corporate overhead gets allocated or what happens when the Seller’s product is folded into a larger brand with competing products becomes unbelievably important. Again, remember the incentives. With a poorly structured earnout, a company like PepsiCo could be incentivized to buy a brand like Poppi and purposely underinvest in the brand in order to eliminate a key competitor to its other products. So PepsiCo could earn more by driving more revenue to products other than Poppi, while simultaneously reducing the earnout payable to Poppi because Poppi's direct performance declines. PepsiCo wins -> Poppi loses. Sellers have to be very careful about how the accounting for the earnout is defined and whether it causes misaligned incentives. 4. The reasons above are why earnouts are among the most litigated terms in M&A. Sellers often sue buyers claiming the buyer sandbagged performance. And Buyers defend by saying “The contract gave us full discretion." Courts will generally enforce whatever terms the parties agreed to in writing, so an argument that Buyer acted in “bad faith" rarely saves a seller who didn't negotiate adequate protections. 5. If you agree to an earnout, protect it at all costs! > Tie it to metrics like revenue, which are subject to less manipulation than metrics like Adjusted EBITDA. > Include strict operating covenants around things like required budget, sales support, and no diverting customers to other products or business lines. > Push for audit rights and a dispute mechanism. > Demand acceleration of the earnout if the buyer or product line is sold, merged, shut down, or deprioritized. > Keep the measurement period short! The longer the period, the more opportunity it gives a Buyer to game the system. To be transparent, I don’t have any background into what happened here. I have no idea if the earnout was poorly structured or if PepsiCo acted in a way to purposely reduce the earnout. That's not the point of this post. What I do know is that a $300M earnout that is written down to $12M is a tale as old as time and almost certainly to end up in litigation. And even if not the case in this particular instance, in most cases where this happens, there's often things that could have been done in the transaction documents to avoid it. My advice to every seller I represent who is considering agreeing to an earnout is simple: Value the deal based on cash at close and treat the earnout as a bonus. If you get it, great. But don’t count on it!