5 Questions to Ask Before Negotiating an Earnout

Before selling your business in a deal with an earnout, consider these issues carefully.

Exiting a business is a huge accomplishment. While we all would love a unicorn IPO, most exits are private transactions that involve multiple terms and conditions. One common approach is for the buyer to pay some amount at signing and another amount over time, often conditional on the business's ongoing performance. For a buyer, it's a way to offset some of the risks and uncertainties. For the seller, it's a way to increase their overall payout.

Commonly referred to as an earnout, this can create a more complicated set of decisions for the seller. It's not a simple transaction with the buyer getting the business, and the seller getting cash and walking away. Earnouts can take various forms, but they all put the seller's remaining payment at some degree of risk. If you're staying on to run the business, you have a much more involved set of considerations.

As a strategic business coach, I've worked with many founders who have sold businesses and have also gone through the process myself with my own business. Before any of my clients consider an offer that involves an earnout, I make sure we discuss these key questions.

1. Are you willing to walk away?

Once you sell your company, you're no longer in control. Someone else is the boss. As much as you can do your due diligence and feel comfortable about the new deal, it's not your show anymore. If you're attached to the earnout and need the money, you'll be in a bind. And for all of the founders I've worked with, that wouldn't go well.

In all of the deals I've been involved in, I make sure that the seller is OK walking away from their earnout. We make sure whatever they have in their hand at the close is enough. If they stay for the earnout, great, but they don't have to. It doesn't mean it will be fun or pretty, but they could do it if they have to. That's the only way to avoid the bind.

2. What's your chance of success?

I've seen deals with huge earnout potential, but when I dig into the conditions and targets that need to be hit, it's clearly a hail mary play. I'm fine with some stretch goals, but we want a base scenario that is highly doable and profitable. Make sure your plan is feasible and that you feel capable and resourced appropriately to hit your targets.

What makes this more complicated is that you will likely not have as much control as you had previously. The new owners can limit investment, block or force hires, control policies, etc., which will likely impact your ability and/or increase the difficulty of hitting your numbers.

3. How will your day-to-day change?

All of the founders I work with cherish their autonomy and control. As much as they might complain about being overworked and demanding a routine, they secretly love it. Why? Because they have control and, in the end, it's their choice. Even if they get up at 4 a.m. to get to the office, they know they don't have to--they choose to.

Once you sell, your control and autonomy will be limited. Even if you retain management control, you will be under more pressure to work within set structures, follow new policies, attend meetings, etc., which you will not have as much control over. For some, this is fine. For others, it will feel like a prison sentence.

4. What's your opportunity cost?

While staying on for a few years might give you a second bite at the apple, you'll be putting in serious effort over an extended period. It's not free money. It's an earnout. Consider what you might do with that time otherwise. Maybe you'll start a new business? Maybe you'll spend some time with that family you've been neglecting? Maybe you'll just take some time to breathe? Those are valuable, and you'll be giving them up.

At a minimum, you want to ensure you're being compensated for your time and energy. In addition to any earnout for the value of the sale, you want a hefty executive package with its own benefits and bonuses. Ideally, that would also include a severance package if anyone decides that the plan isn't working.

5. Do you like your new boss?

Once you sell, you'll have a boss. This will be literal if you're joining an existing leadership team and there is an existing CEO. If you're staying on at the head of the company, you'll be reporting to a board that will have governance rights and control big decisions. Either way, you'll have to answer to someone. Do some research and talk with others to ensure you're comfortable with the relationship and feel like you can develop an effective working relationship.

Answering these questions will help you decide if you're ready to do a deal and stay on going forward. While you might not get perfect answers to all of them, having thought about them will help you be prepared for things that come up. In the end, there is no perfect deal, but you can certainly avoid a nightmare with some careful consideration.