How to Max your Earnout
What owners AND employees need to know to win when on this clock
Welcome back to The Workaround. I’m Bob, your host 👋
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Recently, I had the chance to join John Warrillow on his podcast, Built to Sell. He’s the best in the business at pulling stories and success tips from sellers. I’ll wait patiently if you’d like to click over there now…
[Note: you might also enjoy my post, “What are Eight Years of Your Life Worth?”, which John mentions in our conversation]
Long after selling my last company, I still tune into John and his guests weekly. Why? I find the Hero’s Journey of building and selling a business fascinating. Each has unique ups and downs, and the process shapes each person.
In preparing for my discussion with John, I wondered what I could bring to the table that would be different than the other 479 guests he has spoken with. It was not an easy assignment!
But I kept thinking back to a surprising consistency I’ve heard in John’s interviews: Most earnouts don’t work out—and that’s a shame.
I’ve been fortunate on the other side, going 2-for-2 in selling companies and maxing earnouts. Nothing was easy, and we got lucky as hell. But each time I hear of others’ struggles, I wish I had a chance to share my experience with them beforehand.
Whether you hope to sell your company someday, are an employee at a company that goes through this, or are just curious, come with me for a peek behind the curtain at an interesting, under-reported corner of the business world…
Where I’m Coming From
For background—and since I’ll be alluding to these two experiences in my tips and stories below—here are the details on the two companies that I’ve owned and sold:
Company 1: Digital Agency
Name: Bridge Worldwide.
My Roles: Partner, head of client success, strategy, and new business.
Summary: Creative agency in Cincinnati that had been around since the ‘70s. My team and I joined its founder as co-owners to evolve it into a leading digital agency with large corporate customers. Revenue was ~$10 million at the date of acquisition, and EBITDA was +20%. Money raised: $0.
Why sell? Agency holding companies were behind in the digital revolution and needed to do M&A to retain clients and take advantage of the budget shift. Valuations soared, but there were only so many gaps to fill. We also knew there would be a long earnout and wanted to get that clock ticking so we could eventually do something else in our careers.
Buyer: WPP, the world’s largest agency holding company at the time. Sold in 2005 and completed earnout in 2011.
Deal & Earnout structure: $50 million total potential price, but only 10% upfront and ~90% due at the end of five years, based on a combination of both revenue and profit growth.
Result: We hit our max goal 18 months early—despite getting zero business from our holding company or its sister agencies. Our keys to success were a great culture and retaining clients as they “added a zero” to their digital marketing budgets over time.
Company 2: Social+Influencer Platform
Name: Ahalogy
My Role: Co-founder & CEO
Summary: VC-backed startup launched in 2012, eventually became a tech-enabled service packaged as a media buy. Focused on large brand+retail media campaigns. Revenue was ~$9 million at the date of acquisition, and EBITDA was +20%. Money raised: $10 million.
Why sell? Influencer marketing was growing quickly at an attractive valuation. And since we raised money from investors, they needed to be paid out at some point.
Buyer: Quotient (f.k.a. Coupons.com), a Silicon Valley-based public company that provided promotions, media, and data to large consumer brands. Sold in 2018 and completed earnout in 2020.
Deal & Earnout structure: $50 million total potential price. $20 million paid upfront, and up to $30 million in earnout based on a revenue target over 19 months.
Result: Thanks to our hot product, killer team, and the parent company’s +100-person salesforce, we hit our max goal three months early. Our revenue grew from $9 million to $60 million in two years.
What and Why Earnouts
An earnout is “a contractual provision stating that the seller of a business is to obtain future compensation if the business achieves certain financial goals.” You hit X, you get $Y. And there are infinite ways to structure X and Y based on both sides' needs and negotiation skills.
Earnouts can be requested by the buyer and/or seller for a few key reasons:
The acquired business is “unstable”—Buyers of businesses most fear that their investment in a company falls short of expectations. Many things can go wrong after the deal is done: Big clients leave, staff departs, the economy craters, competitors win, or innovation disrupts. An earnout helps mitigate these risks. Generally, the “less stable” the business, the more any payment will rely on a larger, longer earnout period. This is one of the main reasons that service business acquisitions usually have earnouts while software businesses don’t. Clients of the former can fire you at any time. Those of the latter are locked into longer contracts with integrated technology.
Growth is “variable”—When a buyer offers a price to a seller, they almost always base the number on industry benchmarks, which are usually financial. For example, a service business's going rate might be 10 times its EBITDA or a software company's 7 times its revenue. These “going rates” are a mixture of what public companies in these industries are trading at and the general gut feeling of those who buy and sell. But if you have a fast-growing business, you don’t want to be priced on the revenue or profit you are experiencing today. So, an earnout is a way for a seller and buyer to share the risk and upside of a bigger number in future years.
“Industry standard”—Some things go into contracts because they are a custom, tradition, or habit of the marketplace. “We’ve always done it this way” is a powerful force in human behavior. You’ll especially hear things like this when you’re a noob to the process, and the seller has many more negotiations under their belt. But remember, you don’t have to accept anything as “standard.”
Note that an earnout is much different than “Rest and Vest,” in which a company mandates that you stay on for a certain period before you get all or part of your payment. In such fortunate cases, you don’t have to hit a future number—you just have to make sure you don’t do unethical or illegal things that could get you fired with cause.
For everyone else, we’ve got a lot of work to do! A clock is counting down, and a big pile of money is sitting there if you hit your targets before it expires. It’s like a reality game show without cameras filming—but the ratings would soar if they did!
Here are five things sellers should know when going into their negotiations:
1. Look for a Strategic Fit
The first rule of negotiating a positive exit for your company is reminding yourself continually that you don’t have to sell. This assumes that you don’t really have to sell. There are exceptions to every rule, of course.
When you don’t have to sell, it gives you the mental flexibility to look out to the future and make an educated guess on how likely you will be to hit your earnout number as part of the acquirer. You hope for the best and plan for the worst, but it helps either way when you formulate a strategy that fits.
My easier example here was in selling our influencer agency, Ahalogy. We built relationships with other large companies in the CPG+Retail ecosystem that sold multiple products to their clients—but lacked their own influencer solution. We had a small sales team that was growing quickly with these same clients. Our team won 50% of the opportunities they created, which is a hot freaking product! So, strategically, it was clear that selling to one of these companies would allow us to quickly scale.
Our Quotient offer included two key points that added to our confidence. First, the target revenue growth rate was roughly the same as we predicted we’d hit without their team’s help. Second, 18 months earlier, they had acquired another product that scaled and maxed its team’s earnout. So, this was a strategic no-brainer.
Bridge, our digital agency, was similarly growing quickly, but we didn’t have the strategic need for growth from a parent company. For us, the story was all about retention.
Our large enterprise clients made us their digital agency of record, so any work involving 1’s and 0’s went to us. Early on, a client brand like Pepto-Bismol might spend $30k a year with us—often calling us 3 weeks before the fiscal year ended and dumping this grand sum into a website update. But the winds of change shifted to digital. The next year, they spent $300,000. And the next, it was $3 million.
So we just needed to hold on tight and not let the bigger, sexier NYC/LA/SF-based agencies steal our lunch money. We called our strategy Productive Paranoia.
That made us think: If we’re worried they’ll beat us, let’s join ‘em! Aside from the nice price, being a part of the giant holding company gave our clients confidence that our little Midwest team was the real deal. It also gave us many insights and relationships among the power players—even if we quickly learned they didn’t know what they were doing.
We hoped being digital experts in the big holding company would bring some extra business, but we didn’t need it to hit our goals. And that was a good thing…Within the first week, the CEO of our sub-group screwed up his client communication, and we were suddenly pushed out into the holding company’s version of the Land of Misfit Toys.
Set your strategy before you negotiate!
2. Negotiate with the Future
As I mentioned in the Whys of Earnouts above, they can be a great tool for setting a price today when tomorrow’s value could be much higher.
I told my Corporate Development counterpart, Sunny (now a good friend), when he approached me with an offer of $19 million for our business in 2018. How did we get him to $50 million a few days later? Was he lowballing? Yes…and we made a great case for growth.
His original offer might have made sense for our $9 million business then. But our revenue had been $5 million last year and $2.5 million the year before that. We had a winner on our hands and knew how to at least double our business each year by expanding our sales team.
When Sunny mentioned that number, I smiled and said that I might as well push this conversation to next year, when he’d have to write a much bigger check. He heard my point and returned with an earnout structure that allowed us to lock that value in now and give his company security in case we came up short.
You can do this, too—just make sure you’re confident that the good times will continue!
3. Retain Control
You’ve built a successful business, and you and your acquirer are banking on the good times to keep rolling. But what happens when you sign the deal and leaders from your new company start trying to pull the levers you control? Well, that often risks screwing up a good thing.
Language around control is a big part of any acquisition contract with an earnout. It’s worth digging into the details.
Retaining control not only prevents your buyer from screwing things up, but it also helps keep your team focused on delivering the earnout. You don’t want them distracted with worry and change around a new boss, reporting structure, or countless bureaucratic rules. Nothing is better than telling the team everything is business as usual.
But you must keep your promise and defend them!
The biggest downside is that it can rub your new business partners the wrong way. I’ve had my share of dustups with CEOs who didn’t like me pushing back on proposals and with internal bureaucrats eager to carve my team up like a Thanksgiving turkey just to add boxes to their org charts. But here’s a line you can use to brush ‘em back:
“I see the rationale for your suggestion, and it could work, but I’m worried about the risks. Look, you guys bought us because we’ve built a model that’s working well. While we’re under the earnout, I’ve got a responsibility to my shareholders and employees, and I can’t accept this risk.
You will have moments where it would be easier to give in, avoid conflict, and be the nice guy. Fuck that. You owe it to your team, investors, and yourself to hold the line if the change they desire will risk your earnout—knowing that you might even burn a bridge that leads to your unceremonious termination once the earnout is done. I’ve been there. Don’t let it bother you. They don't deserve your talents if they don’t appreciate your perspective.
4. Watch Caps and Floors
This is where I went 0-for-2 in my earnouts—but at least in the “good way.”
In negotiating the financial goals and resulting payouts, you’ll often have something like a sliding scale. In my last company, for example, we agreed on a revenue goal of around $25 million, which would unlock a targeted earnout payment of $20 million. The slider looked something like this:
Anything less than 70% of the goal, or $17.5 million, and we got $0. This is was Floor.
We received a corresponding share of the earnout if we achieved between 70% and 99% of the goal. For example, 80% of the goal would be 80% of the earnout amount, or $16 million.
If we reached the $25 million goal, we would receive 100% of the earnout amount, or $20 million.
To further incentivize us, there was an upside. If we exceeded our goal, we got a corresponding share. 150% of the revenue goal would unlock 150% of the earnout payment, or $30 million. This set a Cap on how much would be paid out.
My two-time mistake was agreeing to a cap—because we hit that amount early in both companies. At our agency, we maxed with 1.5 years to go, leaving something like $13 million on the table if we had no cap. We probably would have gotten even more money because we hit cruise control once we were maxed out. Show me the lack of incentives, and I’ll show you a lazy leadership team.
I can see why a buyer would want to limit the amount it pays out, but this can backfire on both parties in the win-win structure of an earnout. Maybe I’ll negotiate better next time.
5. Share the Wealth
As I hope is clear by now, earnouts can involve a lot of money over a long period. You not only need to keep the business from crashing, you’ve got to grow—sometimes aggressively. How do you do that? Well, there’s nothing more powerful than a motivating goal for your team.
My friend Eric loves to throw around clever business phrases. Some of his classics include “Companies are Bought, not Sold” and “Easy to Buy, easy to Sell.” But the phrase that has paid the most for me is “Pigs get fed, Hogs get slaughtered.” In other words, share the wealth with your team rather than hoarding it all yourself.
Sure, it’s almost always the right and responsible thing to do, but even a heartless capitalist can see the value of locking in and incentivizing the team that does all the hard work.
In my first company, we created a phantom equity pool for our senior team leaders. We cut them in for a long-term incentive like we had. It was smart, but I wish we had made it even broader.
I fixed that error in my second company. We negotiated a $3 million carve out in the earnout, and every employee before the acquisition could earn about an extra year’s salary if we hit our number.
From that day forward, my team was completely focused on the prize. They took change in stride, came up with new ideas, built deep relationships within the new company, and kept smiles on their faces. Only one person left during those two years, and that guy is still kicking himself for leaving money on the table.
We also created a special budget for goal-based events to motivate our team further and allow employees hired after the deal closed to participate. We threw one big party once we cleared our 70% goal, a bigger one once we hit 100%, and when we hit our 150% max, we flew everyone to Cancun for the weekend.
Seeing the money in your bank account is pretty cool, but sharing the journey and celebrating with your team is much cooler and more memorable.
There is happiness, freedom, and security in the financial outcomes of earnouts, even though the years of getting to those checks are full of challenges. Through the good times and bad, I found it incredibly clarifying and motivating to see that number and know that you and your team are locked in on it together. In a business world defined by unpredictability and disruption, a deal like that is as close to a sure thing as you can get.
I hope you get to go for it someday, too.
If you need help getting there—or a shoulder to cry on—please connect with me on LinkedIn or schedule a time on my calendar.
SECRET BONUS POST
You made it this far, so you deserve something special…
Guide to Keeping Your Sanity During an Earnout
I had way too much content to share in this single post—and I’ve got some stuff that—well…he, he—I’d rather keep away from ALL the eyes of the Internet. So, that means you’ve got to do a tiny amount of work to get it…
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Jamal Baloch
Jamal Baloch