Sellers hate earnouts.

They hate them because they do not get their money upfront and they must hit performance or retention goals to get that earnout. Sellers always feel that after the transaction, the buyers will figure out a way to make sure they don’t get the earnout or trim some of their return. The data suggests that this is true; the vast majority of earnouts are never maximized by the seller.

Buyers love earnouts.

To them, it ensures they pay only if the company is truly what the seller says it is. If the company does not perform as expected, the seller pays less. It’s also a way to hold back some of the purchase price in case things go sideways in the deal. Sellers use it as an offset for escrow.

What value do earnouts have in a sale transaction for the buyer and seller?

  1. They help bridge the value between what the seller wants in a purchase price and what the buyer is willing to pay.
  2. They spread the “risk of the transaction” between the buyer and seller more evenly.
  3. They help “get a deal done”.

Here are some guidelines for earnouts that make them work better:

  1. Keep it simple and absolutely measurable. For example, gross sales, employee or customer retention rate are reasonable. Provide as much detail on how the earnout will be measured in the purchase agreement as possible.
  1. A complicated earnout formula will almost certainly ensure a conflict between buyer and seller post-closing. It’s never a good thing when lawyers become involved after a transaction is completed.
  2. Evaluate the seller and buyer’s control over achieving the earnout. The buyer can sometimes negatively impact the seller getting paid.
  3. Sellers should get payment of the earnout on a quarterly basis when goals are achieved. Do not wait a year to be paid since more can “go wrong” in that time.

Remember, the only guaranteed amount of money you sell your company for is what you get on closing day.

Sellers should not count on maximizing the earnout. They should ask themselves; if I only get the guaranteed portion of the sale price at closing, will I be satisfied with that. If the answer is yes, consider the earnout only as an upside bonus.