How to sell a business: earnouts and deferred payments

Decoding Earnouts and Deferred Payments for Business Owners

Steve Murphy

Steve Murphy


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Decoding Earnouts and Deferred Payments for Business Owners

While payment delays mainly benefit the acquirer, it can also be deployed as an incentive for the seller, offering an additional payout if the business exceeds expectations. Discover the hidden potential in your business sale and learn how to avoid potential traps, such as ceding excessive control to the buyer.

Congratulations, you’ve successfully sold your business! The prospect of a second home in Portugal is undoubtedly enticing, but before you bask in the sun, it’s crucial to delve into the intricacies of earnouts and deferred payments, elements often embedded in business sale deals.

Unlocking the value in your business

Every business deal concludes with an agreed-upon price, but this doesn’t always translate to an immediate windfall. Buyers often include deferred payments and earnout clauses, transferring a portion of the risk back to the seller. For instance, a £1 million deal might involve a deferred 25%, contingent on achieving specific financial targets within a set timeframe.

The shared risk benefits both parties, allowing the buyer to test the business’s health and validate the seller’s future claims. While this approach seems to favour the buyer, earnouts and deferred rewards can serve as incentives for the seller, providing an additional payout if the business performs well.

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Identifying hidden potential when selling your business

If you perceive the initial 75% as a fair reflection of your business’s value at the time of sale, the extra 25% a year or two later could feel like a welcome bonus. In fact, some deferred schemes propose payments beyond the agreed 100%, acting as incentive schemes that enable both buyer and seller to share in future success.

Imagine leaving the business not just with the agreed purchase price but with an additional sum reflecting the success during the deferral period. Such incentivized deferrals often act as icing on the cake rather than diminishing the overall value.

Remaining part of the post-sale team

Deferred payment offers are, at their best, a vote of faith. While earnouts typically relate to shareholders, forward-thinking organizations might extend them to management teams, encouraging key personnel to remain and share in the business’s anticipated long-term success.

When negotiations have fostered trust, deferred payments during earnouts can result in a positive outcome for all involved, ensuring a smooth transition and sustained success.

Navigating the pitfalls of earnouts

Despite the optimistic scenarios, sellers should be aware of potential pitfalls. A pragmatic and one-sided arrangement may arise, especially in situations where the seller’s business is overly reliant on a single customer. If the buyer fears the loss of this customer during the deferral period, they might propose delaying part of the payment.

The reaction to such proposals depends on the seller’s risk tolerance and the specifics of the agreement. Sellers must carefully evaluate whether the deferred portion is fundamental to their financial expectations or if it represents an unexpected bonus.

Earnout tips for exiting business founders

Agreeing to earnouts and deferred payments requires caution to avoid potential traps. Sellers should be wary of deferring too much of the purchase price, as it may shift undue power and control to the buyer. Additionally, elements beyond the seller’s control, such as post-completion decisions made by the buyer, should be carefully considered.

To safeguard against these potential challenges, sellers need legal and M&A specialists in their corner. Experienced negotiators can navigate the complexities, ensuring fair, balanced, and proportionate outcomes, minimising the risks associated with earnouts and deferred payment schemes.

In conclusion, a well-negotiated sales and purchase agreement, guided by expert advice, can lead to a successful earnout and deferred payment scheme. Ideally, the agreement becomes a testament to trust, honesty, and mutual benefits, residing in a drawer and rarely revisited after the deal is done.

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