Earn-out agreements are one of my favorite creative financing strategies for buying a business. Remember, each deal is a unique story.
For example, you can structure an earn-out agreement using metrics like revenue growth, EBITDA, profitability, or customer retention.
It's always easier to explain with a simple example. Let's say you're buying a software company:
Earn-out Metric: Revenue growth
Trigger: Achieve 20% annual revenue growth for two consecutive years
Payout: Seller receives an additional $1 million per year for each year the trigger is met
Or, if you're buying a retail chain, the earn-out could be proposed like this:
Earn-out Metric: EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization)
Trigger: Achieve a combined EBITDA of $10 million across all stores within three years
Payout: Seller receives 10% of the additional EBITDA exceeding $10 million
Two more important points about earn-outs:
Capped payouts: Sometimes, a maximum payout amount is set to limit the buyer's potential liability.
Escrow accounts: Funds for potential earn-out payments might be held in an escrow account until performance triggers are met.
Hope this helps! Let me know if you enjoyed this article.
I hope this is helpful!
Sebastian H. Amieva