EarnOut Strategy

September 03, 2024

by a searcher from IE Business School in Madrid, España

Hello, I am about to sign an LOI with $ 9 M Payment Upfront (3.0x EBITDA) and 4 Millions in Earnout $2 in 2025 and $2 in 2026.
Any recommendations when setting the target for the payment? Ex: growth on EBITDA, Paid 0-100%?

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Reply by an investor
from University of Pennsylvania in New York, NY, USA

Congratulations on being able to push so much of your purchase price to deferred! You didn't ask but one thing you should consider is how are you going to pay for the earnout if it achieves 100% payout. You can of course try to make it "self-funding" where EBITDA growth will drive the earnout, but watch out, as that kind of growth can drive a lot of other cash flow needs like working capital and capital expenditures. I'd recommend talking to your bank about a delayed-draw commitment where you can get a larger loan based on the higher EBITDA.

Reply by a searcher
from University of Maryland at College Park in New York, NY, USA

Be careful... Earnouts are great but the water gets deep very quickly. You are trying to incent the former owner to help u to run a biz he no longer controls. Tough! You may be rightly hiring staff and investing in the biz. However if u are paying me on anything tied to profitability I'm screwed if the earnout is tied to that! Fuels resentment often cured in court. Pay him off something he can help with rev growth or gross margin. Or flip the script and use a profit share %. He thinks the biz can grow to the moon, great here is a 5yr profit share. If he is right he will make more than asking...

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