When you’re in the business-for-sale market, it can take some creative deal making to put together an agreement that makes everyone involved happy – and sometimes that creative deal making involves an earn-out.
What is an earn-out?
This type of arrangement is typical when the value of a business to a seller is much higher than the value to a buyer, usually because of expected future earnings. Here’s an example:
A small boutique clothing manufacturer has recently secured a major contract with a very large retailer, a contract that will significantly raise the value of the business over the course of the next few years. The seller of the business, who has worked long and hard to secure this deal, wants to be paid for the future value of the business. A buyer, on the other hand, only wants to pay for what the business is currently worth – not including any potential future earnings.
One way to bridge this massive valuation gap is the earn-out.
How does it work?
A buyer pays the seller an initial amount, then (as in our above example) as the boutique manufacturer reaches certain milestones with the new large retail contract, the seller gets paid for those milestones. In an earn-out the valuation gap is bridged by paying for the future earnings as they happen instead of paying for the promise that they might.
Is an earn-out for me?
Not likely. As you can see from the above example, an earn out requires a very specific set of circumstances. Most business deals involve seller financing or loans from the SBA (Small Business Administration) instead.
How do I find out if an earn-out would be appropriate for a business I’m selling or considering buying?
Ask your business broker. Any experienced and qualified business broker will be able to advise you on the right type of deal for your business or for any business you are considering.
Have more questions about creative deals? Want to know if an earn-out is for you? Ask us! Please feel free to leave us a comment or question and we would be happy to help.