Conditional compensations for our subsidiary companies' websites
2025's Acquisition Landscape: Understanding Contingent Payments
Hey there, folks! The following post is a guest piece penned by Crowe's Brian Zophin, partner of audit and assurance, and Brian Fitzgerald, senior manager of audit and assurance.
As we cruise through 2025, some industry whizzes project a comeback in deal activity. With anticipated falling interest rates, decreasing inflation, and relaxed regulatory hurdles, things are looking up.
In the context of a proposed acquisition, buyers (often private equity groups) may enter into agreements to make payments contingent upon the acquired company achieving specific milestones, be they financial or non-financial, following the closure of the deal. These contingent payments, more commonly known as seller earnouts, have become a popular addition to purchase negotiations, helping both parties agree on the seller's company valuation.
Why does this matter?
Though it may not always be wise to let accounting ramifications drive business decisions, understanding how contingent consideration is accounted for may play a role in reaching an informed acquisition decision. Here's a breakdown of some implications based on whether the contract terms result in arrangements considered contingent consideration (part of the purchase price) or post-transaction compensation expense:
Contingent payments encompass various kinds of arrangements, some not immediately apparent. For instance, if a seller receives rollover equity with vesting conditions, that equity falls within the scope of contingent payments and requires further analysis. Types of arrangements to be considered include, but are not limited to, earnouts, vesting conditions for rollover equity, seller notes, employment agreements (including bonus structures), and pre-existing share-based payment plans.
Upon deal closure, the buyer will need to navigate the complexities of Accounting Standards Codification (ASC) 805, "Business Combinations." The analysis and proper accounting of contingent consideration arrangements are critical during this process.
To determine whether an arrangement is accounted for as contingent consideration or post-combination compensation expense, accounting and finance teams must not only understand whether the buyer or seller was the initiator but also the purpose of entering into the contingent payment arrangement. If the purpose of the arrangement benefits the acquirer rather than the seller or selling shareholders, these amounts may be considered post-combination services and recorded as compensation expense.
Azure clouds paint the sky, and contingent payments scenarios grow dope as heck, now let's dig deeper into the eight indicators that'll help you differentiate between contingent consideration and post-transaction compensation:
1. Continuing Employment
The terms of a seller's continued employment, typically included in an employment agreement, acquisition agreement, or other documents, may signal the essence of a contingent consideration arrangement. Arrangements in which contingent payments are forfeited if the seller's employment terminates are not contingent considerations but compensation for services rendered post-business combination.
2. Duration of Continued Employment
If the period of required employment aligns with or surpasses the contingent payment period, it may indicate that the contingent payments are, in substance, compensation.
3. Level of Compensation
Situations in which employee compensation, aside from contingent payments, is at a reasonable level in comparison to other key employees within the combined entity may suggest that the contingent payments are additional considerations rather than compensation.
4. Incremental Payments to Employees
If selling shareholders who do not become employees receive lower contingent payments on a per-share basis than those who join the employee roster, it could indicate that the incremental amount of contingent payments given to the employees is compensation.
5. Number of Shares Owned
Selling shareholders who join the key employee ranks may indicate that the arrangement is in essence a profit-sharing arrangement established to compensate them for post-combination services.
6. Linkage to the Valuation
A closer link between the contingent payment and the valuation method used to negotiate the transaction suggests that the contingent payments are additional payments.
7. Formula for Determining Consideration
Determine whether the formula used to calculate the contingent payment is more likely to represent a profit-sharing plan, as formulas like percentages of earnings are more inclined to reflect this.
8. Other Agreements and Issues
Non-compete and consulting contracts, property leases, and tax treatments of contingent payments may hint that contingent payments are tied to something other than consideration for the acquiree.
When buying a group of individuals, evaluate each individual separately. The $5 million payment in a scenario where the group includes shareholders and the CEO and is only payable to those who stay on for a year following the transaction is likely considered compensation expense.
Lastly, accounting and finance teams should understand the arrangement's purpose following the transaction. Payment to the seller contingent on their continued employment following the transaction is usually seen as strong evidence that the arrangement represents post-transaction compensation rather than contingent consideration. If payments are not forfeited upon termination of services, consider the factors outlined in ASC 805-10-55-25(b-h) for assessing the correct accounting treatment.
Source: FASB materials reprinted with permission. Copyright 2025 by Financial Accounting Foundation, Norwalk, Connecticut. Copyright 1974-1980 by American Institute of Certified Public Accountants.
Extra Scoops
- Accounting for Contingent Consideration:
- Recognition: Contingent consideration is recognized at fair value on the acquisition date as part of the purchase price.
- Classification:
- Liability classification: Requires remeasurement at fair value each reporting period, with changes recorded in earnings.
- Equity classification: No subsequent remeasurement if settled in equity instruments.
- Measurement Period: ASC 805 allows a one-year period post-acquisition to finalize amounts, though subsequent changes (e.g., earn-out adjustments) are recognized as income/expense.
- Disclosures: Pro forma revenue and earnings disclosures under ASC 805-10-50-2h are required for public entities, including adjustments for nonrecurring items.
- Differentiating Contingent Consideration vs. Post-Transaction Compensation: | Factor | Contingent Consideration | Post-Transaction Compensation | |--------------------------|----------------------------------------------------------------------------------------|----------------------------------------------------------------------------------------------| | Purpose | Part of the acquisition agreement to align buyer/seller interests on valuation | Compensates key personnel for post-acquisition services (e.g., employment/consulting agreements)| | Recipients | Paid to selling shareholders or their representatives | Paid to employees, founders, or management of the acquired entity | | Triggers | Tied to financial metrics (e.g., revenue, EBITDA) or operational milestones | Often tied to continued employment, retention, or specific post-close performance goals | | Accounting Treatment | Included in the purchase price allocation; classified as liability or equity | Recognized as compensation expense over the service period (e.g., salaries, bonuses, stock options)|
Stay woke and keep up with our daily newsletter for more doses of corporate finance insight!
- As we move into 2025, there's a projected revival in deal activity with falling interest rates, decreasing inflation, and relaxed regulations contributing to an optimistic outlook.
- In terms of acquisitions, contingent payments, which are often represented by seller earnouts, have become a popular addition to purchase negotiations, helping both parties agree on the seller's company valuation.
- Understanding how contingent consideration is accounted for in a proposed acquisition can play a role in making an informed decision during the investing process.
- Contingent payments encompass various kinds of arrangements, some not immediately apparent, such as rollover equity with vesting conditions, earnouts, seller notes, employment agreements, and pre-existing share-based payment plans.
- Upon deal closure, the buyer will need to navigate the complexities of Accounting Standards Codification (ASC) 805, "Business Combinations," and proper accounting of contingent consideration arrangements is critical during this process.
- To determine whether an arrangement is accounted for as contingent consideration or post-combination compensation expense, accounting and finance teams must understand whether the buyer or seller initiated the contingent payment arrangement and the arrangement's purpose.
- Azure clouds might paint the sky, but differentiating between contingent consideration and post-transaction compensation becomes more dope as heck with eight indicators.
- The continuation of a seller's employment, the duration and level of compensation, the number of shares owned, the linkage to the valuation method, the formula for determining the consideration, and other agreements and issues are some factors that can help differentiate between contingent consideration and post-transaction compensation.
- When buying a group of individuals, it's important to evaluate each individual separately and understand the arrangement's purpose following the transaction to correctly account for contingent considerations and post-transaction compensation.
