Conditional payment for the associated company's websites

Conditional payment for the associated company's websites

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As the year 2025 unfolds, some experts predict a resurgence in deal activity thanks to lower interest rates, less inflation, and loosened regulatory barriers. In such mergers and acquisitions, a common practice is for the buyer (typically a private equity group) to make contingent payments to the seller once certain benchmarks—financial or otherwise—are met after the deal is closed. Known as seller earnouts, these arrangements can assist both parties in reaching an agreement on the seller company's valuation.

Why does it matter? It's crucial for potential acquirers to comprehend the financial implications of these contingent payments, as understanding how they are accounted for can potentially impact business decisions. Here's a rundown of some key implications, based on whether the contract terms position the payments as part of the purchase price (contingent consideration) or as a post-transaction compensation expense.

Various types of arrangements fall under the umbrella term 'contingent payments.' For example, selling shares with vesting conditions could be considered contingent payments and require further analysis. Some other examples to keep in mind are:

• Earnouts
• Rollover equity, seller notes, or other types of consideration with vesting or employment conditions
• Employment arrangements for sellers, including bonus arrangements
• Preexisting relationships, such as ongoing share-based payment plans, including plans that continue after the acquisition or require post-acquisition service

Upon closing the transaction, the buyer faces the challenege of navigating the complexities of Accounting Standards Codification (ASC) 805, "Business Combinations," including the proper accounting for contingent consideration arrangements.

To determine whether an arrangement should be treated as contingent consideration or post-combination compensation expense, the accounting and finance teams must understand if the buyer or seller spearheaded the contingent payment arrangement, as well as its primary purpose. If the purpose benefits the buyer rather than the seller or sharingholders, these payments may be considered post-combination expenses and recorded as such.

Top 8 indicators for contingent consideration vs post-transaction compensation

ASC 805-10-55-24 states that "Whether arrangements for contingent payments to employees or shareholders are contingent consideration in the business combination or are separate transactions depends on the nature of the arrangements." To provide clarity, ASC 805-10-55-25 lists eight indicators that help distinguish between the two:

1. Continuing employment: The terms of continuing employment by the selling shareholders who become key employees may provide insights into the nature of the contingent consideration arrangement. Factors to consider include employment agreements, acquisition agreements, or other documents outlining these terms.

If contingent payments are automatically forfeited upon termination of employment, they are considered compensation for post-acquisition services. This applies to employment agreements, consulting arrangements, and transition services, whether or not termination occurs.

1. Duration of continued employment: If the period required for employment aligns with or extends beyond the contingent payment period, this might indicate that the contingent payments are, in essence, compensation.
2. Level of compensation: When employee compensation is in line with what other key employees in the combined entity receive, it might suggest that the contingent payments are additional consideration rather than compensation.
3. Incremental payments to employees: If selling shareholders who do not become employees receive a lower contingent payment per share than those who do, this could indicate that the additional payments to the selling shareholder employees are compensation.
4. Number of shares owned: The relative number of shares owned by the selling shareholders who continue as key employees may suggest the nature of the contingent consideration arrangement. If the selling shareholders who own a significant percentage of the acquiree's shares continue as key employees, this might indicate that the arrangement is a profit-sharing arrangement meant to provide post-acquisition compensation.
5. Linkage to the valuation: If the initial consideration transferred during the acquisition is based on the low end of a valuation negotiation range, and the contingent formula relates to that valuation method, this could indicate that the contingent payments are additional consideration.
6. Formula for determining consideration: The formula used to determine the contingent payment can help assess the arrangement's substance. For example, payments based on a multiple of earnings (such as EBITDA) are more likely to be contingent consideration arrangements, while payments made as a percentage of earnings are more likely to be profit-sharing plans, classified as post-combination compensation expense.
7. Other agreements and issues: The terms of other arrangements with selling shareholders (such as non-compete agreements, executory contracts, consulting contracts, and property lease agreements) and the income tax treatment of contingent payments can offer insights into the arrangement's nature.

For instance, in connection with the acquisition, the acquirer might enter into a property lease agreement with a significant selling shareholder. If the lease payments specified in the lease contract are substantially below market, it might suggest that some or all of the contingent payments to the lessor (the selling shareholder) required by a separate arrangement for contingent payments are, in essence, payments for the use of the leased property, which should be recognized separately in the post-acquisition financial statements.

Similarly, if the selling shareholders in a contingent payment arrangement provide consulting services at below-market rates, it's essential to evaluate whether these services are at fair market value. If not, additional assessment will be required to determine the proper accounting treatment.

Group Scenarios

When contingent payments involve a group of individuals—say, an earnout payment of $5 million for a group that includes shareholders and the CEO, with the payout only going to individuals who continue providing services for one year after the transaction—this is often referred to as a "last man standing" arrangement.

However, it's crucial to consider each individual separately, rather than treating the entire group uniformly. While these scenarios are not exhaustive, any contingent payment arrangements involving employees or selling shareholders, regardless of their connection to the acquirer, must be evaluated within the scope of ASC 805-10-55-25.

After the transaction is completed, and the accounting process commences, it's essential for the accounting and finance teams to understand the purpose of the payment arrangement, as well as to evaluate the indicators when analyzing whether the arrangement is for contingent consideration or postcombination services (compensation). If the seller's payment is contingent on their continued employment following the transaction, this is typically viewed as strong evidence that the arrangement represents post-transaction compensation rather than contingent consideration. If payments are not forfeited upon termination of services, further assessment must be done to determine the appropriate accounting treatment, considering factors such as those outlined in ASC 805-10-55-25(b-h).

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This post was authored by guest writers Brian Zophin, partner of audit and assurance, and Brian Fitzgerald, senior manager of audit and assurance at Crowe.

1. In the context of mergers and acquisitions, seller earnouts are common practices for contingent payments to sellers when certain benchmarks are met, assisting both parties in agreeing on the seller company's valuation.
2. Understanding the financial implications of contingent payments is crucial for potential acquirers, as it can impact business decisions when accounting for these arrangements.
3. Various arrangements, including selling shares with vesting conditions, fall under the umbrella term 'contingent payments' and require analysis.
4. Upon closing a transaction, buyers face the challenge of navigating the complexities of Accounting Standards Codification (ASC) 805, including the proper accounting for contingent consideration arrangements.
5. To determine whether an arrangement should be treated as contingent consideration or post-transaction compensation, the accounting and finance teams must understand the primary purpose and the parties who spearheaded the contingent payment arrangement.
6. ASC 805-10-55-25 lists eight indicators that help distinguish between contingent consideration and post-transaction compensation, including the duration of continued employment, level of compensation, linkage to valuation, and other agreements and issues.

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