Sometimes a buyer and seller cannot agree on a purchase price. Based on a subjective interpretation of the meaning or impact of certain facts, you may feel your business is worth 7x EBITDA while the buyer thinks a 6x multiple is more appropriate. As examples: the buyer may feel the most recent EBITDA figures are not necessarily indicative of future potential since the owner had two down years and then a large increase in the current EBITDA; or, the owner has invested heavily in a number of new initiatives that the owner thinks will generate significant returns within the next 18 months and the buyer is not sure of the amounts, the timetable, or the additional monies needed to make the initiatives successful.

In these instances, an Earnout can bridge the gap. An earnout is a contingent payment the buyer makes to the owner IF certain previously agreed upon goals are achieved after the sale of the business. While an earnout can be tied to a near-term goal, the typical earnout period is between three and five years and the owner can usually remain, if they so wish, in their current management position.

Customarily, the seller and the buyer agree on a set of projections; the earnout is typically a percentage of some easily measured item on the income statement such as Revenue, Operating Profit or EBITDA. It can be paid, if earned, at the end of each fiscal year during the earnout period or cumulatively at the end of the earnout period. The variations of an earnout are limited only by the ingenuity and creativity of the owner, advisors, and the buyer.

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