An earn-out is the part of your sale price that you get paid if the business hits the targets after you've sold it.
I've been on both sides of one, as a seller and as a buyer. Done well, it can get you a better overall price. Done badly, it ties you to a business you no longer control and decisions you don't make.
If you're selling your agency, there's a good chance a buyer will put one on the table.
Here's how earn-outs work, the main types, and how I'd think about one if I were in your seat. If you're earlier in the process, start with my guide on how to sell your business.
What is an earn-out?
An earn-out splits your sale price in two.
The first part is paid upfront at deal completion. The rest is paid later, assuming the business continues to perform.
Say a buyer offers $1,000,000 for your agency.
$600,000 is paid at completion.
$400,000 is paid over the next 12 months, if recurring revenue holds.
Hit the target and you get the full $1,000,000. Miss it and you get less.
That $400,000 is the earn-out.
But how that $400,000 gets paid depends on how the earn-out is written. Same example, three versions:
All or nothing. You only get paid if you hit 100% of the target. Hit 95% and you could walk away with nothing. That's a cliff, and it's the riskiest version for you.
Pro rata. You get paid in proportion to what you hit. Reach 80% of the target and you get 80%, or $320,000.
Pro rata with a floor and a cap. You're guaranteed a minimum even in a bad year, and you can earn a bit extra if you beat the target, up to a limit.
Same $400,000, but three very different levels of risk.
Why do buyers ask for earn-outs?
Agency buyers ask for earn-outs to manage their risk.
Sellers know their agency better than any buyer ever will: which customers are solid, and which are one email from leaving.
The buyer doesn't. An earn-out lets them pay for the business as it performs, not just as it looks on paper.
They tend to show up when:
You and the buyer disagree on what the business is worth. The earn-out bridges the gap. (More on how agencies are valued.)
The business leans heavily on you, and the buyer wants to see customers stay after you step back.
The buyer wants to fund part of the price from the business's own cash flow.
They can work for you too. An earn-out can get you a bigger headline price than a buyer would pay all upfront.
This means that you can increase the overall valuation of the sale, simply by standing behind more of it in an at-risk earn-out.
How do earn-outs actually work?
You'll see earn-outs in both asset sales and share sales. If you're not sure which one you're doing, start with asset sale vs share sale.
Every earn-out has the same moving parts. Get clear on each one before you sign:
What's measured. Revenue, profit, customer numbers. This is the most important choice in the whole structure.
How long for. The measurement period, and how often it's checked. Monthly, quarterly or once at the end.
How it's paid. One lump sum at the end, or instalments along the way.
The payout formula. How the payment scales with performance. Many earn-outs cap the upside and set a floor on the downside. So you share in a great year, and still get something in a bad one.
The calculation. How the numbers get worked out. The best agreements attach the calculation itself, often as a spreadsheet, and make its result final unless there's an obvious error.
Disputes. What happens if you disagree. A good agreement sets a process with deadlines, often ending with an independent accountant.
Acceleration. What happens if the buyer sells the business or goes under before you're paid. A good clause makes the rest payable straight away.
The main types of earn-out
Most earn-outs fall into one of five buckets.
Revenue-based. Paid when the business hits a revenue target, like keeping or growing what it bills. For an agency, that's usually recurring revenue, like Care Plans. Easy to measure, but any pricing change the buyer makes moves your number.
Profit-based. Paid against earnings. The buyer controls the costs after the sale, so you have the least say over the result.
Outcome-based. Paid when something specific happens, like hitting a number of new customers. This is the one I prefer now. More on why below.
Escrow or retention. Not strictly an earn-out, but close. Part of the price is held back for a set period, then released if a condition is met.
Time-based. Paid as a percentage of something like revenue or gross margin, over a set time window. There's no target to hit. You get a cut of whatever comes in.
You can even have a mix of these, but avoid it if you can. It's best to keep things simple.
How is an earn-out different from a seller note?
A seller note is part of the price you lend to the buyer. They pay it back over time, usually on a set schedule. It's normally not at risk, because it doesn't depend on how the business performs.
An earn-out is at risk. If the business misses the target, you get less, or nothing.
So if a buyer offers both, read them differently. A seller note is about trusting the buyer. An earn-out is about trusting the target, and how much say you'll have over it.
The earn-out I had as a seller
When I sold my first business, part of the price was an earn-out. It didn't go to plan.
The moment we sold, we stopped being in control. That's how it should be. It wasn't our business anymore.
But the new owner's priorities changed, as they're entitled to. And our earn-out was tied to only part of what they were now running.
So the decisions that made sense for them weren't always the ones that would hit our target. Our incentive got sidelined.
In the end, we worked out a better path together. But it taught me the lesson I still carry into every deal.
When you sell, you're no longer in control. So make sure the new owner makes sense for you, and that your interests are actually aligned.
An earn-out only works if the person running the business wants the same thing you do. Check that before you sign, not after.
What a long earn-out costs a buyer too
Years later, I saw the same problem from the buyer's side.
One deal I did had a long, time-based earn-out. On paper, it was fair and well built.
But while it ran, the business was harder to change. Pricing, contract terms, even which partners we worked with.
Every change risked moving the founder's payout. So a lot of good decisions waited.
I plan on about 6 months to transition a business. That earn-out ran well past it.
That matters for you as the seller too. A buyer who can't change anything can't grow the business your payout depends on.
I learnt that a poorly structured, time-based earn-out can freeze the business just when it needs to change.
Why I now tie earn-outs to outcomes
These days I try to build earn-outs around an outcome, over a set time period.
It's the best way we've found to do it, for both sides.
Sellers know what they need to hit. And the buyer is free to run the business, change pricing and fix what needs fixing, without moving the goalposts.
Red flags in an earn-out offer
Most earn-outs aren't traps. But some are built to be hard to hit.
Here's what I'd look out for:
The target is profit, and the buyer controls all the costs. They can hire, spend and restructure, and every dollar comes out of your number.
It runs for years, not months. The longer it runs, the less the result has to do with what you built.
The maths is "to be agreed". If there's no clear calculation at signing, there will be an argument later.
You can't see the numbers. If you're not entitled to regular reporting, you're being paid on figures you can't check.
Nothing happens if the business is sold. Without an acceleration clause, a new owner could inherit your earn-out, or bury it.
A big share of the price sits behind a cliff. All or nothing on a large amount is a lot of risk to carry for someone else's decisions.
The buyer's plans pull against your target. If what they want to change would make your number harder to hit, that's a structural problem, not a bad-luck problem.
One red flag doesn't mean walk away. It means negotiate.
Questions to ask a buyer before you agree
The answers to these will tell you more about an earn-out than the headline number.
What is measured, and how is it calculated? Ask for a worked example with real numbers before you sign.
What will you change in the first year? Then ask how each change would affect your target.
Who decides pricing, staffing and which customers count? If it's all them, ask what protects your number.
What happens if you sell, merge or restructure the business? You want the answer written down, not promised.
How have your past earn-outs played out? Better still, ask to speak to a founder who's sold to them.
A good buyer will answer every one of these without flinching. If they get cagey, that tells you something too.
How a buyer answers your earn-out questions is a preview of how they'll run your business.
Should you accept an earn-out?
Maybe. It depends far more on the structure than on the size.
An earn-out isn't good or bad. It's a way of sharing risk, and the structure decides who carries it.
If one's on the table, here's what I'd do.
Ask what's measured, and who controls it. If the answer is "only the buyer", push for an outcome you can still move. And check that the new owner's priorities line up with your target.
Lock in the maths before you sign. The formula, the cap, the floor and the calculation spreadsheet, attached to the agreement. Then check what happens if the buyer sells or goes under before you're paid.
Keep it short. Months, not years. If it runs well past the handover, ask why, and what the buyer won't be able to change in the meantime.
Agree what's in and what's out. Some customers or services won't fit the target. Agree upfront whether they stay with you, come across, or sit outside the earn-out, so nobody's splitting revenue every quarter.
Price the alternative. If you'd rather have no earn-out, ask for the all-upfront number. Then decide which you'd actually prefer.
Get those right and you've got the best chance of both sides walking away happy, and your customers barely noticing the business changed hands.
If you want to go further, here's how I'd approach negotiating the sale as a whole.