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Home Q&A Forum What's an earn-out in a business purchase agreement?

Acquisitions

Business Purchase Agreement

California

Asked on Oct 19, 2023

What's an earn-out in a business purchase agreement?

I am looking to purchase a business and the seller has proposed an earn-out as part of the purchase agreement. I am unfamiliar with this type of agreement and need advice on how it works and what I need to consider before agreeing to it. I would like to understand what an earn-out entails and the potential risks and rewards associated with it.

1 Attorney answer

Answer

Acquisitions

California

Answered 251 days ago

James H.

ContractsCounsel verified

Business Lawyer
Licensed in District of Columbia
Free Consultation

For informational purposes, NOT legal advice: In some service businesses, where there is not hard property asset value but the company is making money, an agreement called "earnout" allows the seller to continue working as part of the compensation. For example, a consulting company may have ongoing business that is dependent on the seller being involved, due to familiarity and personal loyalty. These agreements differ from seller financing in that the seller's employment is subject to continued business volume, therefore the buyer has some assurance that the seller (and their friends, co-workers, relatives,etc.) do NOT try to divert the existing customer revenue stream to a different business with similar services. Yes, some sellers cleverly attempt to sell their business and then set up a competitor in their kids, spouse or relative name to recapture the revenue and tiptoe over the non-compete seller clause In these situations the buyer may offer a Earnout to protect their interest and insure the revenue keeps coming in while the new owners learn the detalls and customer base. Other situations where "Earnout" may be preferable include business sales where the subject business is a subcontractor or heavily dependent on one or a small few number of clients, which makes the business revenue stream highly subject to rapid change. Buyers should be careful not to pay for a company AND then also do a "earnout" since that would be paying twice.

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