Q: I sold my agency two years ago. The price was entirely based on an earnout; i.e., instead of a fixed amount, the buyer paid me a percentage of commissions and fees for sales to my client list over the following three years. By about a year after the sale, most of my former clients stopped using the buyer's agency, due to the poor level of service. Other clients continued to do business with the buyer, but I believe that the buyer has neglected to include all of those sales when calculating the installment payments due to me. As a result of all this, the installments have been a small fraction of what I anticipated. Is this situation common? What can I do now to fix it? What should I have done differently?
A: Your situation is not only common, but it also seems to be the prevalent scenario these days, at least for sellers who do not continue to work with the buyer for the entire earnout period. Large-scale client attrition following an acquisition is all too common.
What you can do now depends on exactly what your sales agreement provides. A well-drafted agreement could have provided various operational commitments by the buyer designed to keep the business intact.
For example, your agreement could have provided that the buyer could not reassign your ex-employees away from handling the clients that they were handling before the sale.
Your agreement could also have given you the right to have an accountant audit the buyer's records to find sales that should have been included. Unfortunately, the majority of such agreements that I see for the first time after a problem arises do not include any such protections for the seller.
If yours did not, there is nothing you can do except possibly file suit alleging that the buyer breached an implied covenant of good faith, and ask the court to order an accounting, but such a suit would be costly and probably doomed to failure.
You could have avoided this regrettable outcome in any one or more of five ways.
First, you could have agreed to stay working at the buyer's business for the entire earnout period, retaining the right to make at least some management decisions designed to retain the business.
Second, you could have insisted on a fixed, or mostly fixed price, even if the total were less than you thought you would have received when you negotiated the earnout. Some of the sharpest sellers have taken this approach, and they have been satisfied that they made the right decision.
Third, you could have insisted on a minimum, or floor, so that if the total of payments over the term are less than a certain amount, then the final payment must equal the difference between the amount paid so far and the floor price.
Fourth, you could have insisted on a shorter earnout period, such as just one year.
Finally, as noted above, you could have negotiated limits on the buyer's discretion to treat the business in ways that might reduce the client base, such as a prohibition on firing your former employees, closing or moving offices or changing office hours or days. Some sellers have had as many as a dozen such limits in their agreements.
Mark Pestronk is a Washington-based lawyer specializing in travel law. To submit a question for Legal Briefs, email him at [email protected].