When you sell your business, you'll likely have to accept part of your compensation in the form of an earn-out.
An earn-out is an arrangement where the buyer agrees to pay an additional sum of money (or some other currency like stock), contingent on the business meeting a set of goals in the future that are typically tied to profit, revenue or customer retention. Sometimes referred to as “golden handcuffs,” earn-outs are designed to keep you motivated for a few years after you sell.
Earn-outs have worked out well for some sellers, but they are often a point of frustration for an entrepreneur selling his or her business. The problem is that the earn-out is “at risk”—that is, it is in no way guaranteed. What's more, the buyer has a number of disincentives to frustrate your ability to meet the earn-out goals:
• The buyer wants to minimize the price paid for your business, and you want to maximize it.
• The minute you sign the share-purchase agreement, the incentive for the acquiring company to help you hit your earn-out is gone. Would you actively help Starbucks find ways to charge you more for your coffee? Some buyers unconsciously hamper your ability to succeed, others can be downright hostile.
• The buyer wants to integrate while you want freedom to operate.
When an acquiring company buys your business, it usually wants to integrate (at least the back office) with its own operations. That looks reasonable in print, but almost all efforts to integrate your business will frustrate your ability to hit your earn-out.
Take a simple issue such as salesperson compensation. Your system has worked for years, and you're keen to keep it for the duration of the earn-out. The acquiring company, however, wants you to move your employees to its sales-compensation model. Instantly, you have a mismatch of objectives: The buyer wants control, and you need autonomy.
Entrepreneurs I know have been successful by remaining flexible, bobbing and weaving as they make their way along. You thrive on creativity and innovation, and the acquiring company thrives on process. You need autonomy to operate, yet it requires rules to be followed.
Your broker will be quick to tell you about entrepreneurs who have done well by accepting an earn-out, but ask 10 business owners who have lived through it, and nine will recount an earn-out horror story. Ultimately, most earn-outs end before their time, with the entrepreneur leaving or being removed or the buyer agreeing to an early exit for the entrepreneur.
You'll likely have to accept some form of your sale price as an earn-out. However, walk away from the offer if the cash you negotiate on closing does not meet the minimum you are willing to accept to give up your business.
What's your earn-out horror story? Tell us about it in the comments field below.
Special to the Globe and Mail
John Warrillow is the author of Built To Sell: Turn Your Business Into One You Can Sell . Throughout his career as an entrepreneur, Mr. Warrillow has started and exited four companies. Most recently he transformed Warrillow & Co. from a boutique consultancy into a recurring revenue model subscription business, which he sold to The Corporate Executive Board in 2008. He is the author of Drilling for Gold and in 2008 was recognized by BtoB Magazine's “Who's Who” list as one of America's most influential business-to-business marketers.