If you’re thinking about selling your accounting practice, you’ve probably heard of a lot of options for how to structure the buyout and the subsequent management transition. An earnout is one way you can sell your practice and potentially make more off the sale, though this advantage can come with a few pitfalls.
What Is an Earnout?
In an earnout, the shareholders of a company that’s being sold have the opportunity to be paid an additional sum, on top of an agreed-upon sale price, under the condition that the company hits a certain business target within a given timeframe after the acquisition.
For example, say you’re selling your practice and find a willing buyer. You’re asking $1.1 million, but the buyer can only offer $1 million upfront. You decide to set up an earnout system with this buyer. If the company can generate $100,000 in profit in the six months following the sale, the acquiring shareholders will pay you back that $100,000 to meet your asking price.
During that six months, the buyers own your company, but they can’t take full control of your practice until the earnout period passes. Your company remains a separate entity, and the majority of your staff may stay employed for this period.
What Are the Advantages of an Earnout?
Obviously, an earnout makes it possible for you to get a higher price for your practice. If you meet your earnout goal, the buyers can use that profit to pay the difference in your asking price. You get more money, and the buyers don’t have to go into the red to pay it since it’s now technically coming out of their own profits.
Achieving your earnout target may also be seen as an advantage because the company that’s being bought out is now performing even better than previously. Plus, the delayed payment structure of an earnout means you can defer the taxes on your sales earnings to the next fiscal year so you have more time to prepare.
What Are the Disadvantages of an Earnout?
Earnouts are not a particularly common method of sale, for a few reasons. Introducing a post-sale business target often causes significant delays in the transition process. With your firm continuing to exist as a separate entity, your buyers may have a hard time integrating their new acquisition into their overall business model. The intense focus on meeting a temporary target can create longer-term issues.
If an acquiring firm tries to start making significant changes to the structure of the acquired business before the end of the earnout, you both run the risk of legal conflict. Any changes made by the acquiring firm could interfere with your ability to meet your targets.
How Can I Ensure an Earnout Is a Success?
So how can you mitigate the risks of an earnout and make this acquisition structure work in your company’s favour? One of the most important aspects of a successful earnout is a well-defined timeline and end date. Negotiate a reasonable period of time in which you can work toward meeting your target, but accept that if you don’t meet it, that period can’t be extended.
Consistent monitoring and regular updates are also a must. Communicate frequently with your buyers and shareholders so everyone knows the status of your earnout targets. It’s also a good idea to introduce a sliding scale payment system. That is, agree that even if you don’t hit your target, the buyers can pay back the percentage of your target that you do hit. The situation can be less stressful if you know you’re going to make some money regardless.
An earnout can be a lucrative sale structure for your accounting firm. Just make sure you’re well-prepared and have a plan going into it.