Earnout Structures That Work - The Blueprint System

What Earnouts Really Do

For Buyers: Pay for performance, not promises
For Sellers: Get paid for future growth
Reality: 50% lead to disputes without proper structure

The 5 Types of Earnouts

Structure #1: The Tiered Revenue Earnout

Type	Based On	Best For	Risk Level
Revenue-Based	Top line sales	Growth businesses	Medium
EBITDA-Based	Profitability	Mature businesses	High
Gross Profit	GP margins	Seller staying on	Low
Milestone	Specific events	Project businesses	Low
Customer Retention	Keep accounts	Service businesses	Medium

Example Structure

Base Purchase Price: $1,000,000

Earnout Period: 3 years

Year 1 Revenue: - Under $2M: No earnout - $2M - $2.5M: $100,000 - $2.5M - $3M: $200,000 - Over $3M: $300,000 Year 2 Revenue: - Under $2.5M: No earnout - $2.5M - $3M: $150,000 - Over $3M: $250,000 Year 3 Revenue: - Under $3M: No earnout - Over $3M: $200,000 Maximum Earnout: $750,000

Why This Works

Clear targets everyone understands
Rewards growth, not maintenance
Annual payments reduce dispute risk
Seller motivated to help transition

Structure #2: The EBITDA Percentage Play

The Formula

Earnout = 30% × (Average EBITDA - Baseline EBITDA) × 3 Where: - Baseline EBITDA = Last 12 months pre-sale - Average EBITDA = 3-year average post-sale - Minimum increase: $100k to trigger Example: - Baseline: $500k - 3-year avg: $750k - Earnout: 30% × ($750k - $500k) × 3 = $225k

⚠️ EBITDA Earnout Pitfalls

Buyer can manipulate expenses
Allocation disputes common
Requires detailed definitions
Seller loses control of costs

Structure #3: Customer Retention Model

Perfect for Service Businesses

Structure:

Identify top 20 customers (80% of revenue)
$10,000 earnout per customer retained at year 1
$5,000 additional per customer at year 2
Maximum earnout: $300,000

Customer List: 1. ABC Corp - $200k/year → Worth $15k earnout 2. XYZ Inc - $150k/year → Worth $15k earnout [... continue for all 20] Year 1: 18 retained = $180,000 Year 2: 16 retained = $80,000 Total Earnout: $260,000

Structure #4: Milestone-Based Earnouts

Critical Earnout Definitions

Milestone	Payment	Due Date	Verification
FDA approval obtained	$500,000	Within 24 months	Copy of approval
Patent issued	$200,000	Within 18 months	USPTO filing
Key contract renewed	$150,000	Within 12 months	Signed contract
New location profitable	$250,000	Within 36 months	P&L statement

Define EVERYTHING in Writing

Revenue means:

□ Gross or net?
□ Include or exclude returns?
□ Cash or accrual basis?
□ Include new product lines?
□ Geographic limitations?

EBITDA adjustments:

□ Owner salary normalization
□ Related party transactions
□ One-time expenses
□ Allocation of overhead
□ Capital expenditure policy

Acceleration & Protection Clauses

Seller Protections (Demand These)

1. Acceleration Triggers:

Sale of business = immediate full payout
Material breach by buyer = acceleration
Bankruptcy = immediate payment

2. Operational Covenants:

Maintain similar business operations
No material changes without consent
Minimum marketing spend
Can't fire key employees

3. Information Rights:

Monthly financial statements
Right to audit annually
Access to books and records

Buyer Protection Strategies

Protect Against Manipulation

1. Offset Rights:

Earnout Payment Due: $200,000 - Indemnity Claims: ($50,000) - Working Capital Adjustment: ($20,000) = Net Payment: $130,000

2. Conduct Restrictions:

Non-compete during earnout period
Non-solicitation of customers/employees
Cooperation requirements
Confidentiality obligations

3. Escrow Arrangements:

10-20% of earnout in escrow
Released after audit confirmation
Protects against clawbacks

Tax Optimization Strategies

Real-World Earnout Examples

Structure	Seller Tax	Buyer Benefit	Best Use
Purchase Price	Capital gains	Amortizable	Default choice
Employment Comp	Ordinary income	Deductible	Seller staying on
Consulting Fees	Ordinary income	Deductible	Transition period
License/Royalty	Ordinary income	Deductible	IP-heavy deals

Example 1: HVAC Company

Base price: $2M
Earnout: 20% of revenue over $4M baseline
3-year period, annual payments
Result: Seller earned additional $400k
Key: Clear revenue definition, seller stayed 1 year

Example 2: Marketing Agency

Base price: $500k
Earnout: $50k per major client retained
10 clients identified
Result: 8 retained, earned $400k
Key: Specific client list, objective measurement

Negotiating Earnouts

Seller's Negotiation Points

Start high: Ask for 40-50% in earnout, settle at 20-30%
Shorter period: 2 years better than 5
Multiple metrics: Don't rely on one number
Guaranteed minimum: At least some payment likely
Audit rights: Trust but verify

Buyer's Counter-Points

Longer period: Spreads risk, proves sustainability
Higher thresholds: Pay only for real growth
Single metric: Simpler to track and dispute
All-or-nothing: Hit target or no payment
Integration flexibility: Right to run business

Earnout Dispute Resolution

Pre-Agreed Resolution Process

Step 1: Good Faith Discussion (30 days)

Step 2: Mediation (30 days)

Step 3: Expert Determination (Binding)

Expert determination clause:

"Big 4 accounting firm partner with 10+ years experience in [industry] shall serve as expert. Decision is binding. Costs split 50/50 unless one party position is >20% off determination, then that party pays all costs."

Alternative to Traditional Earnouts

The "Reverse Earnout" or Clawback

Pay full price upfront, but seller must repay if targets missed:

Purchase Price: $2,000,000 (paid at closing) If Year 1 Revenue < $3M: Repay $200,000 If Year 2 Revenue < $3.5M: Repay $150,000 If Key Customer Lost: Repay $100,000 Security: $450,000 escrow or personal guarantee

Benefits: Seller gets money now, buyer gets protection

The Perfect Earnout Checklist

Before Signing Any Earnout

□ Metrics clearly defined with examples
□ Calculation methodology detailed
□ Payment dates specified
□ Acceleration triggers included
□ Information/audit rights clear
□ Dispute resolution process agreed
□ Tax treatment confirmed
□ Operating covenants reasonable
□ Offset rights limited
□ Legal review complete