Module II· Special Situations ValuationIntermediate
Question
What are earn-outs and contingent value rights (CVRs), and how do you value them?
Answer
Earn-out
a variable purchase-price component tied to future performance metrics (typically EBITDA, revenue, milestones). The buyer pays a fixed amount at closing + variable tranches over 1–3 years. Use case: bridging the gap between buyer and seller valuations. CVR (contingent value right): a tradable security that pays out on a specific trigger (e.g. pharma approval, a litigation outcome). Valuing an earn-out:
- Build a probability distribution of the performance targets.
- Compute the expected payout.
- Discount to the closing date at the buyer's discount rate. Valuing a CVR: a real-options model (Black-Scholes or binomial) — a CVR resembles a call/digital option on the trigger event.
Important
clarify the risk allocation and tax treatment.
Deep diveShow more details
Pitch tip
'In middle-market M&A, earn-outs are standard — typically 20–40% of total consideration as an earn-out, a 2–3 year performance period, paid on EBITDA targets.'