Selling a Business? The Pros & Cons of Earn-Out Clauses

Earn-out clauses for the sale of a business are increasingly common. We look at the positives and negatives that every business owner should consider.

In the world of business, it’s not uncommon to include earn-out clauses in transactions. These clauses enable vendors to ‘earn’ a portion of the purchase price based on the performance of the business after the transaction has taken place. Normally, earn-outs will last anywhere from one to three years after the transaction date.

Earn-outs are commonly included in business sales for two main reasons:

1. They can help bridge any gap in price expectations between the vendor and purchaser. An earn-out is a form of “at risk” consideration that allows the vendor to receive a higher sale price if the business performs well after the sale.
2. Earn-outs can be used to incentivize vendors who are continuing to work in the business after the sale. By tying part of the purchase price to the future performance of the business, vendors have a vested interest in maintaining growth momentum post-sale.

Earn-outs offer several advantages for both buyers and sellers in a business transaction:

• The sale price includes a performance-based component, providing a win-win situation for both parties.
• Earn-outs can help to overcome any price disagreements that may be hindering a sale, allowing both parties to reach an agreement.
• If the calculation of the earn-out is transparent and easy to measure, it can minimize any potential disputes between the buyer and seller.
• An earn-out structure can be particularly helpful when the business has underperforming income, is implementing new initiatives, or is experiencing high growth.
• If the business realizes growth during the earn-out period, it can effectively fund the incremental sale price.

An earn-out can be a powerful tool for achieving a smooth transition of a business from one owner to the next. The construction of an earn-out is critical to its success, both commercially and legally. With careful attention to detail, an earn-out can help to ensure continuity and succession in a business, benefiting all parties involved.