Business For Sale- Earnouts

When you have a business for sale, negotiating the exact terms of the sale can be a quite a trying task. An earnout is a way of selling a business that eliminates a lot of uncertainty for the buyer, and allows the seller to profit from the business for some time after the sale.

What is an Earnout?

An earnout is a business sale agreement wherein the seller is entitled to the sale price decided on, as well as further compensation incumbent on the future financial success of the business.

And In Simple Terms?

Say A wants to sell his restaurant for $300,000. She approaches B, and they begin negotiations. B finds that the restaurant hasn’t done particularly well over the past few years and says he is willing to pay only $200,000. A is adamant that the performance of the restaurant is on the upswing and shows B the calculations and statistics to support her claim. They continue this way, unable to decide on a price. Finally they decide to resort to an earnout as a fair way of selling the restaurant. The terms? B initially pays $200,000 for the business, but agrees to pay an additional 7% of gross earnings over the next five years if, and only if the restaurant attains the sales as claimed by A.

I Have a Business for Sale: Should I Opt For an Earnout?

Sellers are often wary of earnouts, as the initial sale price may be lower than the company’s worth. But a well-planned earnout will benefit the buyer and the seller. An earnout will also make the sale move faster, rather than remain stuck with questions like the exact value of the company. Given below are some of the major reasons for considering an earnout as opposed to a conventional sale.

1. Business Environment
Today’s business environment is not ideally suited to stable company valuations. It’s not considered unusual anymore to find a company struggling for years before beginning to break even. This is particularly true if tech companies, but is something to keep in mind with other kinds of businesses as well. With companies burning out overnight, and throngs of people looking to cash in on the next big bubble, buyers are hesitant to rely on conventional pricing methods. Instability aside, buyers also have to take into consideration a host of new factors when buying a company, like the company’s cultural composition, practices etc. In the current business environment, you will find buyers open to innovative, flexible ideas like earnouts.

2. You Can Remain Involved
You started the company, so there are things about running it that only you will know. If you opt for an earnout, you can also negotiate with the buyer so that you remain involved in the company in the position of consultant. You won’t be a regular employee, but will be called in whenever your help is needed. This way you combine your strengths with the buyer’s resources, giving the company a very bright future indeed. And of course, since it is an earnout, you will be entitled to a slice of that very bright future.

3. Attainable Targets
The best thing about an earnout is that often, the earnout itself ensures that the targets projected by the seller become realistic. When Company B is sold to Company A, which is presumably a larger corporation with a larger sales team and an extensive client base, it becomes more likely that Company B will grow at the rate projected by the seller, and meet the desired targets. Say the seller projects a gross earning of $2 million. On its own Company B would probably have had a hard time realizing that target, but under Company A, the target becomes easily attainable. And once attained, Company A naturally benefits from the earnings, and the seller benefits from her share of the profits, as decided by the terms of the earnout.

4. Buying Time
In the tech business, companies often need to act fast to cash in on an opportunity while it exists. In a situation, a small company may have the know-how to address a particular need in the market, but find that it lacks the resources to optimize the market requirement. This is an ideal situation for a larger company to step in and structure an earnout with the smaller company. The buyer benefits from the knowledge developed by the seller, and the seller benefits because the buyer sees to it that the technology reaches everybody who needs it. In addition the buyer also handles pricing, marketing and distribution much more effectively than the seller could have.

5. Tax Advantages
A well-structured earnout can save you, the seller a considerable amount in tax liabilities. Your financial and legal advisors will help you decide what the terms of the sale should be, so that you benefit from this aspect of an earnout.