Earn-outs can be contingent on improved performance (growth) or stable performance (don’t decline).
Earn-outs can be based on overall company performance or tied to specific customer accounts. They can be based on financials, volume, or client retention.
Earn-outs can be based on revenue, gross profit, or EBITDA. To avoid controversy, go as high in the P&L as possible; revenue is best because it isn’t ambiguous and everyone’s interests should be fully aligned. With EBITDA the seller will invariably feel resentment about how your lack of cost-efficiency hurts his/her payout.
Earn-outs can have caps or be unlimited. They can have multiple hurdles.
Earn-out durations can be short (months) or long (years). The shorter, the better.
The payout terms of an earn-out are independent of the earn-out itself. “The earn-out is based on this year’s performance, and will amortize interest-free over seven years.”
Honestly, you can formulate an earnout any way you want. Keep it simple and unambiguous.
The purpose is the same for all types of earn-outs: de-risk the deal, align incentives, and backload payments.
Earn-outs constitute the best tool to bridge negotiation gaps with sellers because you’re construing a win-win based on future performance.
