Using Earnouts in Small Company AcquisitionsBy Scott Dickes
Barbara Taylor, a business broker and NY Times blogger, wrote a good post yesterday that describes how a well structured earnout can be a good thing – for both the buyer and the seller.
What is an earnout? An earnout is a form of contingent purchase price that gets paid to a seller over time based on achieving certain agreed upon milestones. Earnouts can be tied to revenue, customer retention, gross profit, EBITDA or any other metric that is agreeable to both a buyer and seller. Earnouts help protect a buyer from "over paying" for a business because, in the event that a milestone is missed, the additional consideration is not paid. On the other hand, earnouts also protect a seller from selling "too cheaply" because, if the company continues to perform well and the milestones are achieved, the seller gets paid additional purchase price over time.
If a buyer and seller want to do a deal, but the proposed transaction value is too far apart, an earnout helps close the gap. We use earnouts in about half of our acquisitions and the typical earnout consideration represents about 20% of the total transaction value – which is frequently the gap between our value and the seller's value.