Ratchet vs. Earnout

CFA Level II
#1

What’s the difference?

#2

Assuming you are the PE fund, both promise to compensate the counterparty in the future if the business is performing but ratchet deals with the management whereas earnouts deal with the seller of the firm.

Ratchet aligns the interests between mgmt and shareholders.

Earnouts let PE fund avoid paying too high takeover price now and link the purchase price to future business performance.

#3

thanks a million. its clear to me now.

#4

please tell some way to remember this

i kep forgetting it frown

#5

Instead of paying out previous owners, you pay out and earn them out.

Ratchet makes sure the mgmt is working hard for shareholders. It’s like they are a plumber or something lol

#6

i keep forgetting arrangments is in between which parties in both cases