If you’re selling a business, you may find that you and your prospective buyer have two very different opinions on its true value and on the future potential of the company. Are you looking for a middle ground? Consider an earnout, which can help you come to agreement on the price. If you feel financial pressure to sell or want to ease your way toward retirement, but you want to continue staying involved with the business, an earnout also provides great incentive.
What Is an Earnout?
With an earnout, you as the seller can continue to profit from the company’s future success even after the sale. Suggest an earnout as a compromise if you can’t agree on a fair price with your buyer. For example, if you believe the company is worth $500,000 and your potential buyer believes it’s worth $300,000, think about structuring an earnout with the upfront cost being $400,000. Under this agreement, you receive additional money if the business meets predetermined requirements, such as selling a certain amount of products, acquiring a certain amount of clients, or simply generating a certain amount of profit.
The Benefits of an Earnout
If the potential buyer isn’t willing to pay the full asking price, negotiating an earnout can let you agree on a deal anyway — and you may very well end up earning more from the sale if the company thrives under the new ownership, since the company’s perceived value is based on its future performance rather than its current status.
The company also benefits if you stay involved with it either permanently or temporarily during the transition phase. As the previous owner, you bring a wealth of knowledge and experience with you that can help ensure the company’s long-term success.
An earnout also lets you stay involved in projects and ventures you care about, albeit in a different role. For instance, if a chef owns a restaurant but can’t afford to continue paying for rent, ingredients, and other expenses, he can continue cooking and creating recipes at the restaurant even though he doesn’t actually own it anymore. If the restaurant becomes more popular over time, the chef still gets to enjoy the success and the profits. An earnout becomes a great choice if you find you have to sell your company for reasons beyond your control, because you don’t have to abandon your company entirely.
The Downsides to Taking an Earnout
An earnout may not be the right good choice if you don’t see eye-to-eye with the new owner, which can lead to resentment and arguments down the line. Often, business owners prefer to simply sell their business and move on to the next project. A sale with future conditions forces the previous owner to continue to be involved in the company, and there’s no guarantee they’re going to be happy with the changes or that the changes are going to increase the company’s bottom line.
Sometimes the requirements for the earnout aren’t met, in which case you’re unlikely to receive more money going forward. It’s important to structure your earnout properly, as there are many caveats and details to consider. Make sure you work with a good lawyer, and when in doubt, opt for the quick and easy sale with no strings attached.