Explore the intricacies of a recent M&A case involving a privately held PR firm and a New York City-based buyer. Delve into the background, the unfolding dispute, the court’s ruling, and the implications for sellers considering earnouts. Learn valuable lessons from the Hoffman v. Nutmeg Music Inc. case.
M&A Stories
September 24, 2018
This is the story of a recent M&A case involving a privately held Darien, Connecticut-based PR firm (the target). The target’s owner and seller, sued the New York City-based buyer, a brand marketing and production studio. The disagreement stemmed from the buyer’s alleged actions that negatively impacted the target’s net earnings, leading to a loss of earnout for the seller.
Background:
In August 2016, the buyer acquired all the target’s stock, as outlined in a stock purchase agreement and an employment agreement. The seller was entitled to yearly earnout payments for the first two years, calculated as a percentage of yearly net revenues from existing clients.
The buyer, bound by the stock purchase agreement, was prohibited from actions that could defer revenues or improperly reduce the net revenues of the target’s clients. Additionally, the buyer had obligations to retain specific employees and engage with a Darien business acceleration group.
Dispute Unfolds:
Approximately nine months after the deal, the buyer’s CEO expressed dissatisfaction with the acquisition, citing issues with the seller’s management style. In a letter, the buyer proposed significant changes, including dissolving aspects of the target, terminating employees and agreements, and even replacing the seller.
The buyer executed most changes within a month but did not replace the seller, who resigned two months later. The seller then filed a lawsuit, alleging improper reduction of client net revenues and a breach of the buyer’s obligation to safeguard target client net revenues.
Court’s Ruling:
The court sided with the seller, emphasizing the explicit prohibition in the stock purchase agreement against actions that would reduce target client net revenues. The earnout payments were directly tied to these revenues.
Implications:
This case underscores the risks associated with sellers opting for earnouts, despite the initial legal victory. Sellers may face prolonged litigation, stress, and expenses. Additionally, there’s always the potential risk of the buyer filing for bankruptcy.
Lesson Learned:
Consider the bargaining power and weigh the risks before choosing earnouts over receiving the full amount at closing.
Case Reference:
Hoffman v. Nutmeg Music Inc., Civil Action No. 3:17-cv-01848(VLB), United States District Court, D. Connecticut (September 18, 2018).
By John McCauley: I help people start, grow, buy and sell their businesses.
Email: jmccauley@mk-law.com
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