If you’re selling your business, you might be asked to consider an earnout. That’s an agreement between the buyer and seller to base a portion of the purchase price on the acquired company’s future performance. Earnouts are relatively common in small business acquisitions and are frequently used when a buyer and seller are unable to agree on a purchase price.
How Does It Work?
The structure is straightforward: The seller receives an agreed-upon amount at the time of sale plus the promise of a portion of the company’s future earnings. For example, you may agree to take $5 million in cash for your business plus a stated percentage of gross sales over agreed-upon levels for the next four years.
No Crystal Ball
The danger, of course, is that the company won’t perform as expected. For instance, the new owner may decide to take the business in a different direction. Or your customers may not be happy with the change in ownership and take their business elsewhere. And there’s always a chance that if your relationship with the new ownership sours, you may be tempted to opt out early, which could mean forfeiting some (or all) of your payout.
Details, Details
Structuring an earnout can be very complex, even with a simple acquisition. Here are a couple of general guidelines to consider:
- Base the earnout on numbers that are simple, noncontroversial, and easily determined, such as gross sales or revenue.
- Stay involved with the new company in a way that gives you some control over your interests.
The details of your agreement are important, too. Be sure you understand them.
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