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What is an Earn-Out Agreement when selling a business?

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When selling your business, if the buyer disagrees over the perceived value of your business, they may factor in an earn-out agreement as part of the sale. The earn-out agreement will establish a set of financial targets, which if met by the business post-sale, can result in greater financial returns for the business seller.

As part of the agreement, the owner may continue to work for the business following the sale of the company until the end of the transition period. The earn-out agreement will motivate the former owner to help meet performance targets to redeem the financial incentive on offer. Once the business fulfils expectations over a mutually agreed timescale, you will be able to reap financial rewards and earn a larger profit from the sale of your business.

Protecting the business buyer

This protects the incoming owner, diffusing any worries concerning overpayment. If the business thrives and overtakes expectations, a fraction of the funds will be transferred to the original owner, filling the gap in the purchase price.

As the original owner, you can financially benefit from the progress made under new ownership as part of the earn-out agreement. By guiding the business throughout the early days of business transfer, you can put your best foot forward and strive to strike greater profits.

By shedding the weight of ownership and guiding the business as a consultant/former owner, you can combine all your efforts and focus on business development. If the business surpasses expectations, you will be financially compensated, as noted in the earn-out agreement.

This provides an actionable workaround if you are selling your business and believe that the company represents greater value than that recognised by the business buyer. Functioning as a compromise, an earn-out agreement can help solve pricing tensions between both parties.

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How much is my business worth?

An earn-out agreement may be proposed if the buyer fails to recognise the value of your company or believes that it should be valued at a lower price. The agreement can help you reach a middle ground by providing financial protection to the buyer and granting yourself the opportunity to receive greater profits as a result of the sale if the business exceeds expectations.

As part of a business sale, you will conduct a business valuation to calculate how much your company is worth to determine an estimate sale price. The evidence-based exercise will take into consideration the assets, liabilities, profit, and loss of the company.

Goodwill should be factored into the company valuation process as the price paid for the company will reflect how much it can realistically be sold for. The reputation of the business will directly contribute towards the goodwill value, business performance, customer perception and the rate of returning customers.

Intangible assets also contribute to the overall worth of the company, such as shares, patent, and copyright agreements. This can establish brand exclusivity, influencing your price point, the target audience and create added benefits.

The financial returns for the business seller will hinge on the financial growth of the business over an agreed timeframe. During the business sale process, you will need to take into careful consideration what constitutes the value of your business as this will directly impact the sale price and the rank of buyers you attract.

The Selling My Business team are on hand to help you prepare your business for sale, conduct due diligence and negotiate the sale of your company. We also offer a free business valuation to calculate the worth of your company and establish an accurate sale price to maximise business value.

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