Earnouts and asymmetric information - A study of M&A transactions of privately held Swedish SME’s

Abstract

The Swedish business climate is up for a big change. During the coming years many of the 40‐chord entrepreneurs will sell off their family businesses creating a huge need for allocating potential buyers. Conversely, due to the asymmetric information issues surrounding privately held companies, the sellers and buyers might not be able to reach an agreement. In order to cope with these issues, financial intermediaries and M&A specialists have started using earnout agreements, and thus, removing some of the risk from the buyer towards the seller. Our research aims to find out if the usage of earnouts represents the risklevel of the transaction or if it is a standardized tool used by M&A specialists. By analyzing 25 M&A transactions of Swedish SME’s we were able to see that earnouts are not standardized instruments as they do differ between targets firms. Moreover we have found evidence that some uncertainty factors, such as distance between the seller and buyer, have significant effect on the usage of earnouts. Interestingly however, is that the proportion of earnouts does not increase as uncertainty increases. Instead, our study shows that the usage of earnouts is non‐linear, meaning that the earnout is more flexibly used and more custom made in transactions with high uncertainty.