How does an earn-out work?
The buyer pays part of the price at closing. The rest is paid over one to three years if the business reaches set targets, such as revenue or profit.
Example: a buyer offers $5 million, with $4 million at closing and $1 million paid over two years if revenue stays above $8 million a year. If revenue falls short, some or all of the $1 million isn't paid.
What are the risks for the seller?
After closing, you no longer control the business that has to hit the target. The buyer's decisions on staff, pricing or spending can affect whether you get paid.
How can sellers protect themselves?
- Choose the right measure.Revenue is harder to manipulate than profit.
- Define it exactly.Spell out how the target is calculated.
- Keep some control.Agree on what the buyer can and can't change during the earn-out.
- Plan for a resale.Decide what happens if the buyer sells the business during the earn-out.
- Get audit rights so you can check the numbers.
- Check the tax.Earn-outs can be taxed in different ways. Ask your CPA before the letter of intent fixes the structure.
A simple rule: value the earn-out as if it may never be paid. If the cash at closing works for you on its own, the earn-out is a bonus.
Frequently asked questions
What is an earn-out in a business sale?
An earn-out is part of the purchase price that the buyer pays after closing, only if the business meets agreed targets such as revenue or profit. It shifts some risk from the buyer to the seller.
How long do earn-outs usually last?
Most earn-outs run one to three years after closing. Longer earn-outs carry more risk for the seller, because more can change in the business over time.
Are earn-outs good for sellers?
They can help close a gap on price, but they carry risk because the seller no longer controls the business. Sellers should prefer cash at closing where possible and negotiate clear, measurable targets.
