How do earnouts work in a small business acquisition?

How does an earnout work?

The buyer pays a fixed amount at closing. The rest is paid over a set period if the business performs. Every earnout needs these terms in writing:

• Metric. What is measured: revenue, gross profit, EBITDA, or a customer or contract milestone.
• Period. How long the measurement runs and when each payment falls due.
• Formula. All-or-nothing, tiered, or paid in proportion between a floor and a target.
• Cap. The most the seller can earn.
• Accounting rules. Which principles apply, which costs count, and who prepares the statement.
• Buyer covenants. What the buyer must or must not do during the period, such as keep the business separate or maintain staffing.
• Acceleration. What happens if the buyer sells the company or fires the seller before the period ends.
• Disputes. Who resolves disagreements, usually an independent accountant.

Can you use an earnout with an SBA loan?

No. SBA rules prohibit seller earnouts, meaning payments contingent on future performance, in SBA-financed acquisitions. If you are using SBA debt, bridge a price gap another way:

1. Lower the fixed price. The simplest fix if the seller's numbers are not yet proven.
2. Seller note on full standby. No principal or interest is paid for the life of the SBA loan. It can count toward the 10% equity injection, but limited sources together can supply no more than half of the required injection.
3. Seller note not on standby. It is paid on a schedule, and the lender includes it in debt service coverage at a maximum 10-year amortization.
4. A real transition role. The seller may stay as a consultant or employee for up to 24 months in aggregate after closing. Pay for actual work, not a disguised earnout. Confirm the structure with your lender.

Why do only 63% of earnouts pay in full?

Some businesses simply miss the targets. Others turn into disputes about how the targets were measured.

• The buyer changes pricing, staffing or suppliers, and the seller says that caused the miss.
• The buyer allocates head-office costs to the business, lowering EBITDA.
• Customers move between the acquired company and the buyer's other companies, so revenue can't be cleanly attributed.
• The definitions in the purchase agreement were vague.

Which metric should an earnout use?

• Revenue is easiest to measure and hardest to manipulate. The buyer risks paying for unprofitable sales.
• Gross profit is a reasonable middle ground. It reflects pricing and direct costs without arguments over overhead.
• EBITDA protects the buyer best, but it creates the most disputes because the buyer controls so many costs.
• Specific milestones, such as renewal of a named contract, work when one event drives most of the value.

Why are earnouts harder inside a holding company?

A roll-up wants to integrate: shared dispatch, purchasing, pricing and back office. An earnout wants the acquired company kept separate so its results can be measured. Those goals collide.

If you plan to integrate quickly, an earnout tied to the old company's EBITDA is likely to be disputed. Use a top-line metric, delay integration of the functions that drive the metric, or skip the earnout. Rollover equity in the holding company aligns the seller with the whole platform instead. See rollover equity explained.

Worked example: a $4M deal with a 20% earnout

Assume a conventionally financed deal at $4M, with 20% ($800,000) paid as an earnout over two years on gross profit. The targets and results are assumptions for illustration.

1. Paid at closing: $3.2M.
2. Earnout: up to $400,000 a year. Full payment if gross profit is $2M or more. Nothing below $1.6M. In between, paid in proportion.
3. Year 1 gross profit: $1.9M. Share earned: ($1.9M − $1.6M) ÷ ($2M − $1.6M) = 75%. Payment: $300,000.
4. Year 2 gross profit: $1.5M. Below the floor. Payment: $0.
5. Total received: $3.2M + $300,000 = $3.5M, or 87.5% of the $4M headline price.

For an SBA-financed buyer, the same gap would need a lower fixed price, a seller note, or both.

Where these numbers come from: SBA earnout prohibition, seller note and seller transition rules from SOP 50 10 8.1 via Cantrell Law and Beancount; earnout share of value and the 63% full-payment rate (SRS Acquiom data) via Livmo. SOP 50 10 8.1 applies to loans that receive an SBA loan number on or after October 1, 2026 (SBA Information Notice 5000-880695).

Related questions

Is an earnout better for the seller than a seller note?

Usually not. A seller note is a fixed debt the buyer owes regardless of results. An earnout is paid only if targets are met, and in the SRS Acquiom data 37% did not pay in full.

What happens to an earnout if the buyer sells the company?

It depends on the contract. Sellers should ask for acceleration, meaning the full or a pro rata earnout is paid at that sale. Without it, the new owner may have little reason to honor the original targets.

Can an earnout be paid in stock?

Yes. That adds securities and valuation questions, because the seller is receiving shares later at a price not yet known. See how to pay a seller with stock.

How are earnout payments taxed?

Timing and character depend on how the deal is structured. Confirm with a tax adviser before signing, not after the first payment.

What comes next

Earnouts and private stock both ask the seller to trust the buyer's future. Public stock offers a market price instead. Read why sellers accept public stock more readily than private stock.

Related articles

• What is rollover equity and how much is typical?
• How do you pay a seller with stock instead of cash?
• Why do sellers accept public stock more readily than private stock?
• Should a holding company go public, and at what size?

Meraki Dealmakers is a service of Meraki Partners, LLC, an advisory firm. It is not a broker-dealer, investment adviser, business broker, law firm or accounting firm. This article is general information, not legal, tax or investment advice.