Many of the offers I see include an earn-out. A portion of the purchase price is paid only if the business achieves a certain profit after the transfer. On paper, that makes sense. The buyer isn’t sure if the forecast is accurate. The seller says it is. Let the future be the judge of that.
But an earn-out is more than just a calculation. It’s an agreement that spans years, between two parties who, from the day of the transfer, each want something different.
Last year, I facilitated the sale of a family-owned textile maintenance business. The owner’s main priority was that the employees could stay on and that the business could continue to grow. The buyer came from a related industry and had a solid plan. It was a great match.
The indicative offer included a substantial earn-out component, spread over three years and based on profits. I asked the owner one question: Who determines what those profits will look like after the transfer? It’s the buyer. The buyer decides on investments, on personnel, and on which costs go where in the books. The owner would continue to work with the company for over a year, but without any say in the matter.
That’s my objection. Anyone who cannot manage the risk should not have to bear it in the price.
Subordinated loan
We made a counterproposal: a subordinated loan from the seller instead of the earn-out. This also benefits the buyer, who knows exactly what needs to be paid and can first repay the bank and invest in growth.
In the end, we settled on a mix: a fixed portion upon delivery, a larger subordinated loan, and a smaller earn-out. More importantly, we established how profit would be measured—the same way the seller had done in previous years, with a cap on management expenses and precise agreements regarding costs from the rest of the group. These may seem like details, but they determine whether there will be a discussion or a conflict three years from now.
The same applies to warranties
In the purchase agreement, the seller declares, among other things, that the financial figures are accurate and that there are no pending claims. If it later turns out that something is not correct, the buyer can request a refund. That is reasonable, as long as there are limits to it.
Agree on a threshold so that not every minor discrepancy results in a claim. Set a maximum amount so the seller knows the highest possible refund. And establish a time limit so the matter is truly settled after a few years. In addition, disclose everything you know up front. As a rule, anything the buyer already knew will not be grounds for a claim.
What this means for sellers
An earn-out feels like extra money. Don’t count on it until it’s in your account. Focus primarily on the fixed portion. Can you live with that price if the earn-out ends up being zero? If not, then the offer is too low, no matter how attractive the total amount may sound.
Also, think about how it feels to sit on the sidelines for years while decisions are made that you no longer have a say in. For many entrepreneurs, that’s harder than they realize beforehand.
What this means for buyers
An earn-out may seem to reduce your risk. But you’re also taking on a seller who scrutinizes every annual report, wondering if it’s costing money. Every investment that cuts into profits becomes a point of contention. That takes energy—and sometimes it strains the relationship with the person you need to win over customers and employees.
If you want to keep the seller involved, a subordinated loan often works better. The seller continues to contribute ideas without every decision turning into a negotiation.
My advice to both
If an earn-out is included anyway, agree on three things in advance: who decides what; how profit is measured; and what happens if results fall short due to something over which the seller had no control. Put it in writing before signing. It’s too late afterward.
And ask each other the question that almost no one asks: Do we actually want to spend those years together? An earn-out is an agreement for the time after the closing. Treat it as such.
