Jun 18, 2026 · 4 min · 3 segments
In this episode of *Sell Side Shorts*, Michael Stanley breaks down one of the most common deal-making tools used to close that gap: the earnout. Michael explains how earnouts work, why buyers use…
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Um, this is a, um, a structuring lever that buyers can use to help bridge the gap, um, between a seller's expectations or where- what they think their business is worth and what the buyer thinks the business is worth.
So, you know, what it is, essentially, we're gonna- we're gonna say, you know, just using kind of made-up numbers, but let's say your business is worth $10 million, or you, as the seller, believe your business is worth $10 million, um, and the buyer believes that it's worth $8 million.
We agree the business is worth $9 million, but the buyer's still not quite comfortable with, um, the risk associated with that valuation.
And so, you know, maybe we pay $8 million cash at close, and we have a million-dollar earn-out over 12 months, and that earn-out is gonna be a payment that's due to the seller that's contingent on hitting certain metrics along the way.
Um, as a, as a sell-side representative, I try to avoid earn-outs to the maximum extent possible.
I know most people do, but there are cases where it's really the only way to bridge the gap, um, and get a deal done.
Some things that you need to keep in mind when considering an earn-out are, what is this earn-out gonna be based on? Um, oftentimes we advise clients, let's base the earn-out on gross numbers, uh, and not net numbers.
And by that I mean, um, gross revenue, gross margin, um, things that are, are truly operational components of the business.
If we start basing it off of net income or EBITDA, there are expenses, operational expenses that, that are at the discretion of the new owners that are gonna interfere with that, with that number, and we don't wanna be in a position where they're making decisions that may be in, in the best interest of the long-term health of the business that are gonna decrease the metric by which you may or may not get paid.
The other thing is making sure we have a very robust discussion about how we're gonna do the math, when we're gonna do the math, and who's gonna do the math, um, to make sure that, you know, to decide whether or not we've hit our metrics to receive our earn-out payments.
Uh, there's, you know, a myriad of ways to do this, so I won't get into all of them here, but that's a discussion that you should have with your, um, advisory team, uh, and your attorney as they're building the purchase agreement is, how are we going to make sure that, that this is a totally fair process and, um, and we don't end up in a situation where we're now working with the new owners of the business and, uh, friction develops because one side or the other doesn't believe the other side's being fair? That's Sell Side Shorts for today.
Um, this is a, um, a structuring lever that buyers can use to help bridge the gap, um, between a seller's expectations or where- what they think their business is worth and what the buyer thinks the business is worth.
So, you know, what it is, essentially, we're gonna- we're gonna say, you know, just using kind of made-up numbers, but let's say your business is worth $10 million, or you, as the seller, believe your business is worth $10 million, um, and the buyer believes that it's worth $8 million.
We agree the business is worth $9 million, but the buyer's still not quite comfortable with, um, the risk associated with that valuation.
And so, you know, maybe we pay $8 million cash at close, and we have a million-dollar earn-out over 12 months, and that earn-out is gonna be a payment that's due to the seller that's contingent on hitting certain metrics along the way.
Um, as a, as a sell-side representative, I try to avoid earn-outs to the maximum extent possible.
I know most people do, but there are cases where it's really the only way to bridge the gap, um, and get a deal done.
Some things that you need to keep in mind when considering an earn-out are, what is this earn-out gonna be based on? Um, oftentimes we advise clients, let's base the earn-out on gross numbers, uh, and not net numbers.
And by that I mean, um, gross revenue, gross margin, um, things that are, are truly operational components of the business.
If we start basing it off of net income or EBITDA, there are expenses, operational expenses that, that are at the discretion of the new owners that are gonna interfere with that, with that number, and we don't wanna be in a position where they're making decisions that may be in, in the best interest of the long-term health of the business that are gonna decrease the metric by which you may or may not get paid.
The other thing is making sure we have a very robust discussion about how we're gonna do the math, when we're gonna do the math, and who's gonna do the math, um, to make sure that, you know, to decide whether or not we've hit our metrics to receive our earn-out payments.
Uh, there's, you know, a myriad of ways to do this, so I won't get into all of them here, but that's a discussion that you should have with your, um, advisory team, uh, and your attorney as they're building the purchase agreement is, how are we going to make sure that, that this is a totally fair process and, um, and we don't end up in a situation where we're now working with the new owners of the business and, uh, friction develops because one side or the other doesn't believe the other side's being fair? That's Sell Side Shorts for today.
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