What is Earn-out?
The Short Answer
Earn-out explained simply
An earn-out is a way to structure a business sale. Instead of paying the full price upfront, the buyer pays a portion of the price later. This later payment depends on how well the business performs after the sale. For example, if the business hits certain profit targets in the year after the sale, the seller gets an additional payment. It helps buyers and sellers agree on a price when they have different ideas about the business's future value. It also motivates the seller to help the business succeed during the transition.
Real-World Example
The Software Company Sale
A software company is being sold for $5 million. The buyer and seller agree on an earn-out structure. The buyer pays $4 million upfront. The remaining $1 million is an earn-out, paid over two years. The earn-out terms state that if the company achieves $2 million in recurring revenue in the first year after the sale, the seller gets $500,000. If it achieves $2.5 million in the second year, the seller gets another $500,000. If the targets are not met, the seller gets less or nothing from the earn-out portion.
Why this matters
Earn-outs matter because they can make a deal happen when buyers and sellers disagree on value. They allow buyers to pay less upfront, reducing their risk. For sellers, earn-outs offer a chance to get a higher overall price if the business performs well after the sale. They also show the seller's confidence in the business's future.
Earn-outs can be tricky. Make sure the performance targets are clear, measurable, and achievable. Also, define what control the seller has over the business during the earn-out period. Get legal advice to protect yourself.
Earn-outs can be tricky. Make sure the performance targets are clear, measurable, and achievable. Also, define what control the seller has over the business during the earn-out period. Get legal advice to protect yourself.
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