Caps and Baskets: How Buyers and Sellers Negotiate Risk in a Business Sale
A beautifully drafted set of seller promises is worth very little if the cap is too low to recover under or the basket is structured so you can never reach it. This…
An earn-out is part of the purchase price that the buyer pays after closing only if the business reaches agreed results, such as a revenue or profit target, over a set period. It is most useful when the buyer and seller disagree about what the business will earn.
We are candid with clients about earn-outs: they are a frequent source of disputes after closing. The seller no longer controls the business that decides its payment, and the buyer has its own reasons to invest, reorganize or change prices. We draft to reduce that risk, starting with definitions both sides will apply the same way.
Choosing the Earn-Out Metric
Revenue Targets
The simplest to measure and the hardest for a buyer to reduce, which is why sellers tend to prefer them.
Gross Profit Targets
A middle ground that counts the cost of sales but leaves overhead decisions out of the calculation.
EBITDA Targets
Closest to the earnings the buyer paid for, and the most affected by how the buyer runs the business.
Milestone Payments
A fixed payment when a defined event happens, such as a contract renewal or a new license.
Definitions and Control After Closing
Most earn-out disputes are about the calculation, not the target. EBITDA (earnings before interest, taxes, depreciation and amortization) isn't defined by generally accepted accounting principles (GAAP), so the agreement has to say which accounting rules apply and how the buyer's overhead, management fees and integration costs are treated. A sample calculation from the company's historical numbers settles many questions in advance.
Buyers want freedom to run the business they bought, and sellers want protection against decisions that shrink the payment. The usual middle ground is a short list of covenants for the earn-out period: separate books for the business, no shifting of customers or revenue to affiliates, and good faith. Buyers usually keep the final say on strategy.
Reporting, Set-Off and Disputes
Reporting and Audit Rights
A statement for each period by a set date, with access to the records behind it.
Set-off
Whether indemnification claims can reduce earn-out payments, and where disputed amounts are held.
Dispute Resolution
A review window, time to negotiate, then an independent accountant who decides only the disputed items.
Tax Treatment
When the seller reports the payments and whether part is treated as interest, which we settle with the client's CPA.
The earn-out has to fit the price, indemnification and dispute terms of the purchase agreement. Some deals pair a smaller earn-out with seller financing.
How We Build an Earn-Out
Letter of Intent Terms
The metric, measurement periods, targets and maximum payout are agreed before drafting.
Definitions and Examples
The agreement sets the accounting rules and attaches a sample calculation from the company's own numbers.
Operating Covenants
The parties agree on how the buyer will run the business during the earn-out period.
Statements and Review
The buyer delivers a calculation for each period, and the seller can review the records behind it.
Dispute Process
Disagreements over the numbers go to an independent accountant on a set timeline.
Frequently Asked Questions
Have a question that isn't answered here? Call us at (817) 631-8842 or send a message.
Ask a QuestionHow long does an earn-out period usually last?
There is no set length. The period is negotiated deal by deal, along with the metric, the targets and the maximum payout. A shorter period gives the seller an answer sooner and gives the buyer less time to change the business, while a longer one gives the business more time to reach its targets and both sides more time to disagree about how it was run.
What happens to an earn-out if the buyer sells the business?
That depends on the acceleration clause. Sellers ask for a full or formula payment if the buyer sells or merges the business or breaches its operating covenants. Buyers often offer instead to have the next owner take on the earn-out.
Can the buyer offset indemnification claims against earn-out payments?
As a practical matter, only if the agreement allows it, and most buyers ask for that right. Sellers usually try to limit set-off to agreed or finally decided claims, or to have disputed amounts held in escrow. Our article on indemnification clauses explains the claims involved.
What can replace an earn-out in an SBA-financed purchase?
SBA rules prohibit seller earn-outs but allow buyer rebates based on business performance, where the seller refunds part of the price if the business misses agreed targets and the refund pays down the SBA loan. A seller note on full standby or a lower price are the other common answers. See our SBA-financed acquisitions page.
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- Selling a BusinessPreparation, negotiation and closing for owners selling their companies.Learn More
- Asset PurchasesBuying or selling a company's assets while the seller keeps the entity.Learn More
- Stock PurchasesBuying a corporation's shares, with its contracts and its history intact.Learn More
- Membership Interest PurchasesBuying an LLC's ownership under a membership interest purchase agreement.Learn More
- Partner BuyoutsBuying out a co-owner, or selling your stake, on clear terms.Learn More
- SBA-Financed AcquisitionsPurchase agreements and closings built around SBA 7(a) lender requirements.Learn More
- Seller FinancingSeller notes with clear payment terms, security and remedies for both sides.Learn More
- Rollover EquitySellers reinvesting in the buyer, on terms that protect the stake they keep.Learn More
- Selling to Private EquityRepresenting owners who sell to private equity firms and PE-backed platforms.Learn More
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- Franchise ResalesBuying or selling an existing franchise location, with the franchisor's approval.Learn More
- Letters of IntentSetting the price, structure and key protections before the deal is drafted.Learn More
- Due DiligenceFinding the legal issues in a business before the buyer owns them.Learn More
- Purchase AgreementsThe negotiated terms that decide who carries the risk in a business sale.Learn More
- Closing an AcquisitionChecklists, payoffs, funds flow and the follow-up that finishes a deal.Learn More
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