The current economic climate has created a growing disconnect between buyers’ and sellers’ expectations. In light of this, earnouts become a popular tool to bridge this gap.
It’s important to note that earnouts are just one tool in a larger toolkit of potential deal structures, and they may not be the right fit for every transaction. However, given their potential to address the growing disconnect between buyers’ and sellers’ expectations, it’s worth understanding the basics of earnouts and considering their use in your own negotiations.
What are earnouts?
An earnout is a financial arrangement in which the seller of a company or a business interest receives additional payments based on the performance of the company or business after the sale has been completed. The purpose of an earnout is to align the interests of the buyer and seller and to provide an incentive for the seller to ensure the continued success of the company or business.
There are several different types of earnouts that can be used in different situations, depending on the needs and goals of the buyer and seller. Some examples of earnouts include:
Revenue-based earnouts
In this type of earnout, the seller receives additional payments based on the revenue generated by the company or business after the sale. This can be a good option if the buyer is particularly concerned about the long-term revenue potential of the company or business.
Profit-based earnouts
In this type of earnout, the seller receives additional payments based on the profits generated by the company or business after the sale. This can be a good option if the buyer is particularly concerned about the long-term profitability of the company or business.
Milestone-based earnouts
In this type of earnout, the seller receives additional payments based on the achievement of specific milestones or targets set by the buyer. This can be a good option if the buyer is interested in specific projects or initiatives that the seller will be working on after the sale.
Customer-based earnouts
In this type of earnout, the seller receives additional payments based on the retention and acquisition of specific customers by the company or business after the sale. This can be a good option if the buyer is particularly interested in the customer base of the company or business.
Employee-based earnouts
In this type of earnout, the seller receives additional payments based on the retention and acquisition of specific employees by the company or business after the sale. This can be a good option if the buyer is particularly concerned about the talent and expertise of the company or business.
Stock-based earnouts
In this type of earnout, the seller receives additional payments in the form of stock in the company or business after the sale. This can be a good option if the buyer is interested in providing the seller with a long-term stake in the company or business.
These are just some possibilities, but overall, earnouts can be a useful tool for aligning the interests of buyers and sellers and ensuring the continued success of a company or business after a sale. They can be structured in a variety of ways to meet the specific needs and goals of the parties involved.
