An earn-out is a portion of the purchase price the seller only collects if the business hits agreed performance targets after closing. Instead of receiving the full price at the table, the seller waits one to three years and gets paid based on the revenue or profit the firm produces under its new owner.
Why buyers like earn-outs and sellers should be wary
An earn-out shifts risk from the buyer to the seller. The seller's money now depends on decisions made by someone else, with the seller out of control of staffing, pricing, and client service. When targets are missed, disputes follow over whether the business underperformed or the buyer undermanaged it. A typical structure puts 10 to 30 percent of the price at risk; on a $4,000,000 sale that can mean $1,000,000 the seller may never see.
Where earn-outs show up in A/E deals
Earn-outs appear most often when an outside strategic buyer acquires a firm and worries that clients are loyal to the departing principal. The buyer holds back part of the price against client retention or revenue targets. That concern is weakest in an employee buyout, where the people who already hold the client relationships are the ones purchasing the firm.
The alternative: get paid at closing
SBA rules do not allow earn-outs in 7(a) financed acquisitions, which is one of the quiet advantages of a bank-financed employee buyout. The price is fixed, the SBA 7(a) loan funds it, and the seller receives 95 to 100 percent of proceeds in cash at closing, with at most a small standby seller note. For owners comparing offers, a slightly higher headline price with a large earn-out is often worth less than a clean bank-financed price paid at the table.
Go Deeper
Buying and selling an A/E business