Earnouts, a performance-based consideration used in some M&A transactions to bridge the value gap between seller and buyer expectations, have become increasingly popular. Though hard to quantify because of confidentiality, earnouts are found in nearly 30 percent of M&A transactions, according to the American Bar Association, and are more frequently used in deals with values under $250 million.

Earnouts can align buyer and seller interests, incentivizing sellers to stick around post-sale to realize an economic benefit from the continued success of the business. Increasingly, they're being used to align total deal value to the ongoing performance of the business in a period of uncertainty. This method helped buyers during the pandemic address concerns about short-term uncertainty and inconsistencies in business performance attributed to COVID-19. Now, with the looming threat of a recession, retaining key management and owners is increasingly critical, so buyers are leveraging earnouts to drive sellers to remain active and help steady the business through volatile market conditions.

While earnouts can be a useful tool in M&A transactions, they can also be complex and challenging to negotiate and implement. They involve setting clear performance targets and establishing mechanisms for measuring and tracking the company's performance. Still, given today’s challenging economic environment, earnouts will likely remain an important feature in M&A deals.

M&A Market Activity

National deal volume slowed in December 2022, as increasing economic headwinds impacted M&A activity. U.S. M&A deal volume for the month of December 2022 (45.8 percent) was lower than December 2021, while total deal volume for 2022 (21.9 percent) was lower than in 2021.

In December 2022, the Northeast Ohio M&A market proved more resilient than the broader domestic market, as deal volume that month increased by 16 percent relative to December 2021. However, Northeast Ohio deal volume for 2022 (10.3 percent) was lower than the prior year.

December 2022 also saw the closing of several noteworthy transactions in Northeast Ohio, both from strategic and private equity acquirers. Lincoln Electric, Medical Mutual of Ohio, and Saucy Brew Works all completed strategic acquisitions within the month. In addition, Independence-based private equity group Edgewater Capital Partners alongside SK Capital Partners completed an acquisition of Saint-Gobain Crystals, renamed Luxium Solutions, a provider of single scintillation crystals for radiation detection applications.

Deal of the Month

Cleveland-based Union Home Mortgage acquired AmeriFirst Financial Corporation, a home mortgage loan provider based out of Kalamazoo, Michigan. AmeriFirst Financial Corporation provides loans for first homes, condominiums and second homes, and offers refinancing services for existing mortgages, along with additional loan programs and loan calculator services. This strategic acquisition is expected to strengthen Union Home Mortgage's footprint in Florida, Michigan and California, where AmeriFirst Financial Corporation has more than 300 loan consultants. Union Home Mortgage released a statement, saying the acquisition will bring “unique expertise and scale with the USDA Rural Development Single Family Housing Guaranteed Loan Program, which provides eligible applicants mortgage options requiring no money down when purchasing a primary residence.” This is the third acquisition for Union Home Mortgage since 2018.

Carter Hatina is an Analyst with MelCap Partners, LLC, a middle-market investment banking advisory firm. For more information on MelCap Partners, please visit www.melcap.com or email [email protected].