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Valuation group proposes rules for contingent consideration

Tammy Whitehouse | May 24, 2017

A professional valuation group is working on new guidance that would produce formal standards on how to value contingent consideration, a common provision in business combinations.

The Appraisal Foundation issued an exposure draft on how to value contingent consideration, also called an earnout, which is often used to bridge the price gap between what a seller wants to get and a buyer wants to pay in a merger or acquisition. Consideration, or payment, is contingent upon future performance, typically. Payment might be based on meeting any number of targets like revenue, margins, stock price, regulatory reviews, litigation outcomes, covenants, or product development.

The proposed guidance advocates a risk-neutral framework based on option pricing, says Travis Harms, head the financial reporting valuation group at Mercer Capital. “It means the best way to value an earnout is by analogizing to a call option or some combination of call options that do the same thing, and...

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