Analysis: How to prepare for life after earn-out periods

Buying a PR agency under an earn-out scheme may seem like a good way to regain the acquisition price and keep talented founders on board, but what happens at the end of the arrangement?

Mike Kirk's promotion to managing director of Weber Shandwick Square Mile last week (PRWeek, 24 October) is as much about management experience as it is about keeping a new hire happy.

WS needs Kirk, who joined the firm in June (PRWeek, 20 June), to head Square Mile because of the very real prospect that the financial practice's founders, chief executive Susan Ellis and chairman Tim Jackaman, could soon leave, at the end of their earn-outs.

Earn-outs are used to buy successful PR shops in the knowledge that their mechanisms will recoup and insure against the cost of a particularly pricey acquisition. Typically, the buyer of a company makes a down payment based on the previous year's profits, and then pays an agreed multiple of this base profit at the end of a three to five-year period if the business continues to show profits over that time.

The earn-out arrangement with Square Mile's founders goes back to the acquisition of Ellis and Jackaman's firm, then Square Mile Communications, by BSMG for around £10m in November 2000 (PRWeek, 14 November 2000). When WS merged with BMSG in October 2001 (PRWeek, 14 September 2001), the US firm took on the renamed BSMG Square Mile and its three-year earn-out arrangement.

WS chief executive Colin Byrne now faces the end of the earn-out in December, when WS will be contractually obliged to pay Jackaman and Ellis an undisclosed sum under the terms of their original agreement with BSMG.

Other companies that could be facing a similar choice include Harrison Cowley, which was acquired by Huntsworth Group in 2001 (PRWeek, 3 August 2001), and The Red Consultancy, acquired by Incepta Group in February 2001.

The problem with arrangements of this kind is that once the final payment is made there is nothing to keep the very people the business was bought for in the first place.

Although WS will not comment on the negotiations it is having with Jackaman and Ellis, which are understood to involve new cross-practice positions, other firms would do well to take a hard look at the relative merits of these deals and what they store up for the future.

'The biggest worry for buyers is that, at the end of the earn-out, people will sweat the assets in order to get the maximum payment,' says Graham Beckitt, chief executive of Results Business Consulting, which is publishing a study into the success of merger and acquisitions next month. 'They will then leave the business having exploited the company and its employees' - and bequeathe staff who have been overstretched and are low on morale.

But not all are so concerned. Huntsworth chairman Lord Chadlington, who claims to have made around 84 acquisitions, says the side-effect of star talent leaving an organisation can be the actual intention of the earn-out.

'The reality is that the people with whom you have an arrangement will often take the money and leave at the end of that arrangement,' he says.

But, Lord Chadlington adds: 'it is also often the case that you want them to leave', so that the younger staff will be able to realise their potential.

However, the productivity bonus the heads of comms firms hope earn-outs will bring can cut both ways.

First, as Chime Communications chairman Lord Bell explains, the deals can interfere with the rest of your organisation. 'Joint pitches can be difficult if the guy on an earn-out is fighting hard for a higher share of the fees for the business because he wants to meet his earn-out target,' he says.

Second, the over-ambitious founder of a firm that has been doing well may find that they have bitten off more than they can chew.

WPP's agreement to buy financial PR shop Finsbury in 2001 (PRWeek, 10 November 2000), like most earn-out agreements, is shrouded in secrecy.

But it is understood that Finsbury's founder Roland Rudd took a significant pay cut last year, some say to enable the firm to meet the profit targets agreed with WPP as part of Rudd's earn-out.

WPP and Finsbury remain tight-lipped on the issue, although WPP Group finance director Paul Richardson maintains that earn-outs 'have proved to be a very successful way of transitioning an independent-owned business to a corporate environment'.

Whatever the relative merits and shortcomings of earn-outs, a merger technique that allows the founders of successful firms autonomy while giving the buyers security seems set to survive. How communication company chief executives will deal with earn-outs coming to a close in the next few months is another matter.

WS chief executive Colin Byrne concludes: 'The trick is to show that there is life after the earn-out. You buy a company because it has great clients and people, and you fiddle with that at your peril.'

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