Understanding Risks of Earnout Agreements

You just sold your business for $10M… Or did you? Because $4M of that is tied to earn-outs—performance-based milestones over the next 24 months. The problem? You don’t own the business anymore. You’re no longer in control. And suddenly, hitting those targets doesn’t feel as simple as it did in the spreadsheet. Let’s talk about earn-outs. They’re marketed as upside. But in reality? They’re how buyers de-risk—and how sellers often get short-changed. An earn-out is when a portion of your deal value is contingent on future performance. They’re most common when: ◾ Buyer and seller disagree on valuation ◾ The business is founder-led or early-stage ◾ Growth expectations are high, but unproven ◾ The buyer wants the founder to stick around post-sale Here’s the trap: You agree to an earn-out thinking, “I know this business. I can hit those numbers.” But 3 things happen after the sale: 1️⃣ You lose control. You don’t run the team, budget, or strategy anymore. 2️⃣ Priorities shift. The buyer may pivot, cut funding, or redirect resources. 3️⃣ The math gets fuzzy. Revenue attribution, margin calculation, and customer renewals can all be “reinterpreted.” And suddenly that $4M? It’s vapor. Are earn-outs always bad? No. But they’re rarely free money. They work best when: ✅ Based on milestones you control (e.g., staying 12 months, delivering key integrations) ✅ Tied to simple, binary triggers (e.g., “Launch v2 by X date” not “Increase profit by 18%”) ✅ The buyer has a proven track record of honoring them ✅ They’re a bonus—not the bridge making the purchase price “work” How to protect yourself: 🔹 Cap the timeframe (12–24 months max) 🔹 Define exact metrics + reporting cadence 🔹 Avoid pure revenue or EBITDA triggers—blend metrics 🔹 Require access to performance data + audit rights 🔹 Spell out scenarios (restructuring, business pause, early termination) Bottom line: Earn-outs aren’t inherently bad—they’re just misunderstood. They should never be required to make the deal make sense. If they are, you’re not selling… you’re betting. #MergersAndAcquisitions #EarnOut #ExitPlanning #SellYourBusiness #DealStructure #FounderAdvice #StartupExit #MandA

Earnouts can be useful tools to bridge valuation gaps, but they’re sometimes notoriously difficult for sellers to collect. Why? ➡️ Control shifts. The buyer runs the show post-closing. ➡️ Performance can often be manipulated. Expenses can get reallocated, priorities shift, and suddenly targets aren’t met (making a very tight earnout formula critically important for sellers). ➡️ They’re frequently subordinate to debt. If the company has senior loan obligations, your earnout might be at the bottom of the food chain. That doesn’t mean earnouts can’t work, but if you’re relying on one, structure it for success: ✅ Have measurable and achievable metrics. Subjective performance targets invite disputes. ✅ Protect against financial engineering. Buyers shouldn’t have free rein to subtly adjust performance calculations. ✅ Get clarity on creditor obligations. Ensure your earnout isn’t wiped out by senior debt restrictions. ✅ Have a well defined financial dispute resolution procedure. Implement a neutral third party mechanism like what you’d utilize for a post-closing working capital determination. Earnouts can work, but only if structured properly. Otherwise, they’re just a way for buyers to hedge risk at the seller’s expense. Want to know more on what sellers need to do to get earnouts right? See my article in the comments. #earnouts #businessales #founders

When selling your business, you'll face a ton of important decisions. But there's one massive decision you don't want to get wrong: All-cash offer or earnout? Sellers want cash upfront. But buyers want to structure payments over time. That's where things can get tricky. So here’s the advice I always give to the founders we work with: Cash is the ONLY thing that’s guaranteed. Because an earnout might promise you millions in future payouts... ...but anything can happen along the road to a sale (just look at what COVID did to businesses overnight). Earnouts are always going to be higher risk. So if you’re considering one, here are 3 ways to protect yourself: 1. Sell To An Experienced Buyer All buyers aren't created equal. So if you agree to an earnout, you have to know who you’re dealing with. An experienced buyer has a track record. So you can: - Talk to past sellers - Ask how they were treated - See if prior earnouts were actually paid But a first-time buyer? No track record, no insight, and no guarantee. It doesn't mean you shouldn't sell to them, but you must do your homework beforehand. 2. Control The Key Metrics If your earnout is based on revenue growth, but you have no control over product sales after the exit? You’re in trouble. I’ve seen it happen before: A founder's promised 50% of future revenue growth. But the buyer bundles their product with others, resulting in stagnant revenue. The sales team is gutted. And suddenly, no one is selling the product. What if your earnout is focused on EBITDA? The buyer can load extra costs onto the product, tanking EBITDA and killing the earnout. If you don’t control the levers that define your payout, you’re at the buyer's mercy. 3. Build Your Dream Team of M&A Advisors Even the best deal can fall apart if the paperwork isn’t airtight. So my advice is to invest in a top-notch M&A attorney. Onewho ensures everything is crystal clear like: → What protections do you have if things change? → How the earnout is calculated → How it’s paid (important) Because nothing's worse than thinking you've got a great deal, only to realize the fine print tells a completely different story. So if you've got an earnout on the table and you're thinking of accepting it? Ask yourself: → Can I afford to lose it? → Do I really trust this buyer? → Do I control the critical metrics? → Do I have a legal team to protect me? Because once the deal is signed, it’s too late to go back.