How Do You Structure an Earnout? Five Perspectives

Situation: A founding CEO is evaluating a purchase offer for his company. The buyer wants the CEO to retain some ownership interest to assure a smooth transition post sale, and ongoing assistance from the CEO so that the company continues to succeed post-sale. Should the CEO retain a minority share of the company? How do you structure an earn-out?

Advice from the CEOs:

  • The ideal option is full payment up-front. However, if the CEO is perceived by the buyer as critical to the company the buyer will want to have some assurance of continued services for some period.
  • An earn-out of fixed payments over time is acceptable provided that the language of the agreement is acceptable. However, performance-based earn-outs make no sense if the CEO no longer has control over the decisions that will impact performance. Don’t structure the payment as an earn-out, but as a retention bonus and assure that the terms are favorable.
  • Post-sale a minority share of your old company holds no value if you can’t monetize it. Holding a small share of a non-traded company has the same challenges.
    • It is all about liquidity.
    • If the other party offers this, ask what is the value is to you of the retained share.
  • Minimize the earn-out if one is demanded, but don’t count on it.
  • If there isn’t a strategic fit between the buyer and the company, the value of the company in a sale will be lower.

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