A business sale transaction, the earn-out is a seller financed method of purchasing a company. The seller agrees to a specific pay-out after the sale of the business. The seller’s payment is tied to a specific aspect of the business – profits, gross revenue, employee retention rates, for example. The agreement is made between buyer and seller, and is not paid unless the agreement’s terms are met. There is risk for the seller in an earn out – tying the payment structure to profits, for example, may result in a financial loss if the new owner is unable to maintain the company’s profits.

Establishing an earn-out agreement can be a complicated process. The buyer and the seller must both agree to the terms of the agreement. The seller is highly motivated to reach the contingencies of the agreement, while the buyer is generally less motivated. By leveraging an earn-out, the seller is in a position to help the company maintain success through the transition to new ownership. Putting strategies and guidelines in place before the transaction is final will help ensure that the transition is smooth, and that all parties are satisfied with the results. Keeping the arrangement simple and tied to attainable objectives will help prevent frustration.

Using a contract length that is as short as possible will prevent burn-out and ill-will between buyer and seller. Make sure the contract stipulates the key people who the seller wants to retain to ensure their end of the earn out is met. In addition, make sure that you have control over the areas that your earn-out payment are dependent on. Determine who will oversee disagreements and who will track progress of the agreement. An earn out is not always the solution for company sales, but if done correctly can help ensure smooth transitions and successful new endeavors.