When selling a business, one of the most commonly negotiated — and often misunderstood — deal terms is the earnout. For many small business owners, earnouts can be a strategic tool to bridge the gap between what a buyer is willing to pay today and what the seller believes the business is truly worth in the future. Understanding how they work is key to ensuring you get a fair deal.
What Is an Earnout?
An earnout is a contingent payment structure that allows a seller to receive additional compensation after the sale, based on the business’s future performance. Typically, the buyer pays a portion of the purchase price upfront, with the remainder contingent on meeting specific financial or operational targets over a set period—often 1 to 3 years.
For example, if your business sells for $2 million with a $1.5 million upfront payment and a $500,000 earnout tied to revenue milestones, you’ll receive that additional $500,000 only if the business meets the agreed-upon performance goals.
Why Earnouts Are Used
Earnouts are often used when there’s a difference in how buyers and sellers view the company’s growth potential or the sustainability of profits. They can help:
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Close valuation gaps between buyer and seller expectations.
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Incentivize continuity, especially when the seller remains involved post-sale.
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Reduce the buyer’s risk by tying part of the payment to actual results.
Key Considerations When Negotiating an Earnout
While earnouts can create win-win scenarios, they also come with risks if not carefully structured. Keep these points in mind:
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Define clear metrics. Use objective, measurable criteria such as revenue, gross profit, or EBITDA to determine payouts.
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Establish control parameters. Make sure you understand how much influence you’ll retain in business decisions that affect performance.
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Set a reasonable timeline. Shorter earnout periods reduce uncertainty and the potential for disputes.
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Plan for contingencies. Address what happens when external factors—such as market shifts or leadership changes—impact performance outcomes.
Work with Your Advisory Team
Because earnouts can be complex, it’s critical to involve your CPA, legal counsel, and exit planning advisor early in the negotiation process. Together, they can help you structure an agreement that protects your interests, aligns incentives, and minimizes future misunderstandings.
The Bottom Line
Earnouts can be an effective way to balance risk and reward during a business sale—provided they’re well-defined and professionally managed. With careful planning and expert guidance, they can help you achieve a more favorable outcome and ensure a smoother transition to your next chapter.
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This article was written with the aid of artificial intelligence and reviewed for accuracy and clarity.