A contractual provision stating that the seller of a business is to obtain additional future consideration based on the business achieving certain future business goals. An earn-out is a mutually beneficial tool to getting a deal done if it is structured appropriately. Is maximizes the selling price for the seller and it matches the Company’s future earnings with the payments made to the Seller. An earn-out should not provide a financial “burden” on the Company, but should be structured as a sharing of the future earnings. (Earn-outs are prohibited by the SBA.)
Great article on Earnout (https://www.investopedia.com/terms/e/earnout.asp):
An earnout is a contractual provision stating that the seller of a business is to obtain additional compensation in the future if the business achieves certain financial goals, which are usually stated as a percentage of gross sales or earnings.
If an entrepreneur seeking to sell a business is asking for a price more than a buyer is willing to pay, an earnout provision can be utilized. In a simplified example, there could be a purchase price of $1 million plus 5% of gross sales over the next three years.
Key Takeaways
- An earnout is a contractual provision stating that the seller of a business is to obtain future compensation if the business achieves certain financial goals.
- The differing expectations of a business between a seller and a buyer are usually resolved through an earnout.
- The earnout eliminates uncertainty for the buyer, as they only pay a portion of the sale price upfront and the remainder based on future performance. The seller receives the benefits of future growth.
- Key contractual considerations include earnout recipients, accounting assumptions used, and an agreed-upon time period.
KEY TAKEAWAYS
- An earnout is a contractual provision stating that the seller of a business is to obtain future compensation if the business achieves certain financial goals.
- The differing expectations of a business between a seller and a buyer are usually resolved through an earnout.
- The earnout eliminates uncertainty for the buyer, as they only pay a portion of the sale price upfront and the remainder based on future performance. The seller receives the benefits of future growth.
- Key contractual considerations include earnout recipients, accounting assumptions used, and an agreed-upon time period.