The 10 biggest earnout negotiation mistakes to avoid

Earnouts are often a seller’s biggest regret after their exit. Sellers often agree to terms that stack the odds against them.

Here are the 10 biggest earnout negotiation mistakes to avoid...

1/ Getting muddled on your strategy

You need a clear plan, like any negotiation. Do you want to try to get more upfront, a shorter timeline and lower targets? Most sellers do. Or do you want to lean INTO the earnout? Push for a higher cap, adding ratchets for stretch performance.

2/ Negotiating in isolation

An earnout’s terms contains value, metrics, targets and timing. You need to agree all of these as one before you can commit. Force the buyer to discuss the whole package.

3/ Overlooking the metrics

Sellers will fight to the death over targets and timing, but focus less on the metric that they are tracked against. Think about what metric gives you the best chance of success. It’s usually EBITDA or revenue, but you can get creative too. E.g... If you’re concerned about your margins being compressed or costs rising, then revenue might be better than EBITDA.

4/ Forgetting the adjustments

These can have a major impact, but are overlooked. You agree ‘adjustments’ to your P&L for things like value added to the buyer’s group, revenue from co-selling or post-sale cost increases. These must be defined upfront, and backed up with a dispute resolution process.

5/ Getting muddled on the calculation

Aim for a straightforward calc, without over-engineering. As the complexity increases, so does the risk that you and the buyer get your wires crossed. Write a list of performance metrics, and calculate how much you would be paid for each. Get this agreed by the buyer.

6/ Overcooking the forecasts

Be careful of pushing the forecasts too hard… The buyer will likely use these as your earnout targets. Read more in: The Goldilocks Problem: How to get your forecasts 'just right'.

7/ Going all or nothing

You need to protect your downside — a million things can go wrong. So push for smaller payments even for average performance, and for periodic, staged payments rather a bullet payment at the end.

8/ Not bartering on the time period

Regardless of your strategy, a shorter period is better. You get the money sooner (so you get the compounding), and narrow your risk window. Push as hard on the timeline as you do on other areas.

9/ Making a rookie tax error

Tax on earnouts can be nasty - you might get your tax bill before you’ve been paid, and it might be taxed as income. Take some advice early on so you know how much will actually end up in your pocket.

10/ Giving up control

Control, control, control. You need freedom to set the strategy, allocate capital and choose who to hire. The buyer will push back. This tension is the main cause of fall outs during the earnout period. Think carefully about what freedoms you absolutely need, and make sure they are in the LOI. These can be just as important as the earnout terms themselves.

Learn more

This is an off-shoot from our series on earnouts. If you want to dive deeper into how earnouts work, how to get the best deal and how to avoid getting screwed, check these out.

👉 Earnouts: Part 1 - Why and when?
Why earnouts are used and when sellers should expect to see one.

👉 Earnouts: Part 2 - Mechanics
The nuts and bolts of how earnouts work and the mechanics of metrics, targets and payments.

👉 Earnouts: Part 3 - Negotiation
How to negotiate the best earnout terms.

👉 Earnouts: Part 4 - Conflicts (Coming soon)
How to avoid getting screwed.