Introduction: What is an earn-out?

An earn-out is an agreement where part of the purchase price depends on the company's future performance. The buyer pays a basic amount when transferring and adds one or more payments later, provided that certain goals are achieved.

For example, consider a situation where your company is now valued at €1.5 million, but you believe that sales will grow strongly over the next three years. You already want to be rewarded for that. The buyer, on the other hand, does not want to take risks and prefers to pay extra only when that growth actually takes place. An earn-out then seems like a compromise.

Why do parties opt for an earn-out?

An earn-out can be attractive for both buyer and seller.

For the buyer:

• Less risk: part of the price is only paid if the company delivers the agreed performance.
• Security: you don't pay money for growth that ultimately won't be achieved.

For the seller:

• Potentially higher sales price: you get the chance to prove that the company is indeed worth as much as you say.
• Keep participating: as an entrepreneur, you often stay involved to achieve the agreed results.

How does an earn-out work in concrete terms?

The agreements vary by deal, but one of the following criteria is usually considered:

• Turnover: for example, an additional payment if the turnover exceeds a certain level in the next three years.
• EBITDA or profit: often a more reliable criterion, because it also includes costs.
• Specific milestones: like bringing in a major customer or launching a new product.

The duration of an earn-out usually ranges from two to five years. The amount can amount to 20 to 40 percent of the total sales price.

The benefits of an earn-out

1. Bridge between expectations
   Many entrepreneurs rate their business higher than buyers. With an earn-out, you can bridge the difference: the buyer pays a lower upfront amount, but you still get more when the future expectations come true.
2. More deals that continue
   Sometimes a deal breaks because the parties do not agree on the value. An earn-out can save the deal by incorporating flexibility.
3. Incentive for collaboration
   Because you often stay on for a while, the transition becomes smoother. You have an interest in doing well, and the buyer benefits from your commitment and knowledge.

The disadvantages and risks of an earn-out

But there are also significant disadvantages to earn-out structures. For entrepreneurs, these are the most important:

1. You are no longer the boss

After the sale, you no longer decide. If the buyer makes other choices that have a negative impact on the results, this can jeopardize your earn-out. That feels unfair, but it is often difficult to correct legally.

2. Discussions about numbers

The earn-out depends on reports. But how are costs allocated? Is marketing from the new parent company imputed to your company or not? This can result in endless discussions.

3. Extended farewell cycle

Many entrepreneurs just want to let go after the sale. An earn-out means that you will be emotionally and professionally connected to your old company for years to come.

4. Chance of disappointment

In practice, not every earn-out is fully paid out. Unforeseen market conditions, new strategies or simply misunderstandings about the agreements often lead to lower payments than expected.

When is an earn-out smart?

An earn-out can be a good option if:

• You strongly believe in the company's growth prospects.
• You are willing to actively cooperate for a few more years.
• You can make clear and measurable agreements (preferably about EBITDA).
• There is a relationship of trust with the buyer.

When is it better to say “no”?

An earn-out is usually not wise if:

• You want to break away from your company as quickly as possible.
• You have little influence on the results after the sale.
• The agreements are vague or difficult to measure.
• You have little faith in the buyer or their strategy.

How do you make an earn-out workable?

If you decide to accept an earn-out, make sure you have clear rules:

1. Clear definitions
   Define how concepts such as turnover and profit are calculated. Make sure there is no room for interpretation.
2. Limited duration
   Keep the period short, for example two or three years. The longer it takes, the greater the risk of hassle.
3. Transparency in numbers
   Make sure you have insight into the reports on which the earn-out is based.
4. Clear agreements about your role
   Determine how much control you still have and what resources you can use to achieve the goals.
5. Ceiling and floor
   Agree on a minimum and maximum so you know where you stand.

Earn-out versus direct cash

Many entrepreneurs are faced with the choice: receive a lower sales price immediately or a higher price with an earn-out in the future. The trade-off often depends on personal preference.

• Direct cash provides security and peace of mind. You can move on with your life or make new plans.
• Earnout offers the chance of a higher yield, but with more uncertainty and stress.

Ultimately, you have to ask yourself: do I want to invest in my old company for years to come, or do I really want to move on?

Closing

The earn-out is a powerful tool, but not a panacea. It can save a deal and increase the selling price, but it can also lead to years of discussions and disappointments. Success depends primarily on the clarity of the agreements and the trust between buyer and seller.

Time for action

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