Run, don’t offer, if an earn-out is necessary?

June 21, 2022

by a professional from University of Southern California - Marshall School of Business in North Palm Beach, FL, USA

Some searchers say they’ll ignore opportunities that only make sense if the seller agrees to an earn-out. And let’s realize brokers don’t like earn-outs, because their comp is received when the seller is paid (or not). What do you know about this topic?

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Reply by a professional
from University of Southern California in North Palm Beach, FL, USA

Keep in mind the elephant in the room: Buyer competition. (Not forgetting, brokers.) I am commenting on my post thanks to other commenters triggering something that happened to one of my clients who “lost” a deal to buyer competition. We offered an earn-out. The competing buyer did not. Total price was close enough not to matter. The broker said the seller really liked my client, and might have preferred him were it not for the earn-out. Here’s what I, afterwards, said to my client: One of the most things you can do is to know more about whomever “won” your bidding war. For example, if the potential buyer is an ill-informed or ill-advised individual, there’s a good chance that person is taking on more risk at a higher cost than a more-informed buyer would. On the other hand, if the buyer is already in the industry or is diversifying into it, the risk factor is much less. In your case, because the way-more-than safe customer concentration problem and the questionable valuation, there is more risk than what is usually accepted by the most well-informed private parties (who also know how to find more opps). Two things I hope you will seriously consider: Businesses for sale are like buses; more will come by later. And while we’re thinking about lost income opportunity we’re also thinking about unnecessarily accepting more risk than necessary. The better and more active your search, especially if you continue communicating with owners/vendors, the more likely you’ll make the best deal possible. (Searchfunders and searchers: Does it make sense?)

Reply by a professional
from Marquette University in Kirkland, WA, USA

Keep in mind earnouts are also known as, "A litigators best friend." There has to be a reason for an earnout. It can't be for the buyer to pay less than the business is worth or the seller to get more than it's worth. ^Link Moser mentions customer concentration, which is a good reason. So is a new product or service line not developed, a Covid hit, or another disruption like owner death or disability. I don't agree brokers don't like them because they don't get paid 100% at closing. If the business hits their numbers the broker gets paid more. And remember, SBA loans can't have an earnout but can have a clawback (talk to an SBA lender like ^Lisa Forrest for details on this.

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