What is an Earnout?
Definition
An earnout is a contingent payment provision where additional purchase price is paid based on the business achieving specified post-acquisition performance targets.
When Earnouts Are Used
Earnouts bridge valuation gaps. If a seller believes their business is worth $500K but the buyer only offers $400K, an earnout can split the difference: $400K at closing, plus up to $100K if revenue or profit targets are met.
Common Earnout Structures
- Revenue-based: 10-15% of revenue above a baseline threshold
- Retention-based: Bonus for keeping key customers or employees
- Profit-based: Percentage of EBITDA above a threshold
- Milestone-based: Fixed payments for achieving specific goals
Earnout Risks and Considerations
- Measurement disputes: Define metrics clearly in the purchase agreement
- Buyer control: Buyer controls operations and could depress earnout metrics
- Integration conflicts: Seller may resist changes that hurt earnout
- Accounting method: Specify GAAP vs. cash basis for calculations
Earnouts in Trade Business Acquisitions
For HVAC, plumbing, and electrical businesses, earnouts often focus on customer retention. A typical structure: 20% of the purchase price contingent on retaining 80%+ of recurring service customers for 12-24 months.
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