Applying Lean Analytics to Performance Metrics in M&A Earnouts

Abstract: Ever since the dawn of internet, a new wave of fast-growing software companies has emerged. The M&A scholars have struggled to find appropriate valuation mechanisms for unprofitable companies with ultra-high revenue growth. To overcome the uncertain future, a contractual provision called earnout is often used. An earnout is a contractual provision in a M&A-deal that states the seller of the business is to obtain additional compensation in the future if the business achieves certain metrics. The purpose of this study is to contribute to practice and nascent literature by exploring and evaluating metrics for SaaS-companies that can be used in earnouts. The study applies Lean Anaslytics to suggest a framework for choosing what metrics to use, and discusses how to avoid sub-optimisation and metric manipulation. In order to answer the research questions, a qualitative, exploratory and abductive methodology was used. The study combines a literature and thought leader review and interviews to explore certain areas, with a case study that applies the findings. The study suggests that the process for determining metrics should start with the buyer’s acquisitions strategy. For acquisitions where the objective is to access talent, technology or accelerate product road-map, the study has shown that earnouts in most cases not be used at all. If the acquisition is made based on financial objectives, Lean Analytics can be used to determine what stage the seller’s company is in. Understanding what stage the company is in is crucial as the type of metrics that matter differ depending on stage. The study suggests that the most suitable earnout metric for M&A based on financial objectives is monthly recurring revenue (MRR). The metric must be clearly defined so it cannot be manipulated. The reason why many other metrics from Lean Analytics cannot be used is that they are vulnerable to manipulation and can restrict the operating freedom for the entrepreneur.