Performance risk management for earnouts should be integrated throughout the entire transaction process

Securities Times Reporter Hu Minwen

Repeated breaches of performance commitments and difficulties in enforcement not only affect the interests of listed companies but also reveal shortcomings in the entire M&A transaction process. How to improve the rationality of betting agreements from the source, strengthen performance guarantees, and increase enforcement efficiency has become an urgent issue for all market participants. In response, several industry insiders have offered targeted suggestions.

First, diversify assessment indicators, shifting from a single profit-oriented approach to a long-term value orientation. The key is to break the “profit-only” mindset, balancing short-term performance with long-term development, so that betting agreements better align with the company’s actual situation and avoid the promise-maker sacrificing long-term competitiveness for short-term profits.

“Metrics such as non-recurring net profit, revenue, operating cash flow, R&D investment, market share, and customer retention rate can be combined to build a comprehensive assessment system. Especially for tech-focused targets, emphasis should be placed on evaluating R&D investment and the implementation of core technologies to prevent the promise-maker from sacrificing long-term R&D for short-term profits,” said Gu Chunfeng, Senior Legal Advisor at Jintiancheng Law Firm in Shanghai. “Additionally, establishing a flexible performance commitment adjustment mechanism that considers force majeure factors and adjusts the performance commitment amount based on actual circumstances can make betting agreements more commercially reasonable and practically feasible.”

Second, build a three-in-one performance guarantee system of “prevention, control during the process, and post-transaction remedies,” integrating risk prevention throughout the entire transaction process.

Gu Chunfeng, combining experience in commercial mediation and legal practice, proposed specific risk control measures: “Pre-transaction, set up multiple guarantee measures, requiring the promise-maker to pledge or mortgage shares of the listed company, the target company, or real estate they own, and require the actual controller to provide personal joint liability guarantees. For cross-border transactions, foreign assets or third-party cross-border guarantees should also be arranged. During the process, establish a performance and fund co-management mechanism, dividing performance assessments into stages, with partial compensation triggered if stage-specific targets are not met. Core funding accounts of the target company should be jointly managed to prevent fund transfers. Post-transaction, improve judicial remedies combined with commercial mediation; before litigation, negotiate compensation plans through pre-litigation commercial mediation to reduce costs; during litigation, promptly apply for property preservation to freeze the assets of the promise-maker; for cross-border enforcement cases, leverage judicial cooperation mechanisms to connect with foreign courts to achieve asset seizure and enforcement.”

Renowned tax and finance expert Liu Zhigeng said: “Control the payment schedule of the transaction price, making payments in installments based on the achievement of the target company’s performance, and retain part of the remaining payment to ensure risks are manageable after the commitment period ends.”

Third, foster multi-party collaboration to build a healthy M&A ecosystem. During the betting process, responsibilities of the listed company, intermediary agencies, and the target should be clearly defined, encouraging all parties to shift from passive compliance to proactive actions, thereby collaboratively improving the quality of performance fulfillment.

“The listed company should strengthen due diligence and clause design, conduct cautious valuation, and avoid blindly accepting high-growth promises. Financial advisors and accountants need to thoroughly analyze the reasonableness of the target’s profit forecasts during due diligence, paying special attention to overly aggressive plans. Legal advisors should assist the listed company in designing breach remedies to reduce subsequent litigation costs. Meanwhile, regulators should further strengthen disclosure requirements, urging listed companies to regularly disclose operational data and progress on commitments, and focus inquiries on projects that consistently fail to meet targets,” said Hu Shanggang, Professor at the Business School of Taizhou University, Nanjing Normal University.

Partner Luo Ji of the professional M&A consulting firm Puli Kangtu believes that regulators need to balance investor protection with market vitality. Current policies already have clear regulations to prevent and pursue actions that harm investors’ interests. At the same time, for some strategic emerging industries, higher valuations can be tolerated to avoid stifling market vitality.