You've negotiated a $4M sale price — but the buyer wants $500K of it contingent on hitting revenue targets over the next two years. That's an earnout. They're common in plumbing business sales, especially when there's a gap between what the seller thinks the business is worth and what the buyer is willing to pay at close.
Earnouts can be fair. They can also be traps. Here's how to tell the difference.
Why Buyers Use Earnouts
Earnouts exist because of disagreement on value — usually about the future. The seller says "we're about to land a $500K commercial contract and our revenue will be up 30% next year." The buyer says "I can only pay for what I can verify." The earnout bridges that gap: if the growth materializes, the seller gets paid more.
Buyers also use earnouts to reduce risk. If a key customer leaves or revenue underperforms, they've paid less for the business than the headline price suggests. From the buyer's perspective, it's a form of insurance.
How Earnouts Are Typically Structured
| Component | Common Structure |
|---|---|
| Metric | EBITDA, revenue, or gross profit — EBITDA is most common and most defensible |
| Period | 1–3 years post-close; 2 years is most common |
| Threshold | Must hit a minimum to trigger any payment (e.g., $1M EBITDA) |
| Payment structure | Linear (% of metric), tiered (step-up at each threshold), or binary (all-or-nothing) |
| Cap | Maximum earnout payment, regardless of outperformance |
| Acceleration | Sometimes: early payment if metric hit in year 1 |
The Biggest Risk: Buyer Control Over the Business
Here's the core tension with earnouts: after close, the buyer controls the business. They control pricing decisions, hiring, capex investment, and marketing spend. All of those decisions affect your EBITDA — the metric your earnout is measured on.
A buyer who is motivated to avoid paying the earnout can do so legitimately: they can raise overhead, invest in growth (which reduces EBITDA), change pricing, or run expenses through the business. You hit your revenue targets but EBITDA is below threshold. Earnout not paid.
This happens. It's not always malicious — sometimes buyers genuinely invest in growth and it temporarily compresses margins. But the structural tension is real.
How to Negotiate an Earnout That Protects You
- Use revenue, not EBITDA, if possible — revenue is harder for a buyer to manipulate than EBITDA
- Define the metric precisely — "EBITDA" means nothing without agreement on what's included/excluded in the calculation
- Cap buyer discretionary changes — require buyer consent from seller for any overhead changes exceeding X% during earnout period
- Require management continuity — if the buyer removes key management during the earnout period, you get early payment
- Negotiate acceleration on sale — if the buyer sells the platform before your earnout period ends, you receive full earnout immediately
- Get quarterly reporting rights — access to financials during the earnout period to verify calculations
- Dispute resolution mechanism — require independent accountant review if you dispute the earnout calculation
When to Accept an Earnout vs. Walk Away
Earnouts are sometimes fair and sometimes a way for buyers to lower their effective purchase price. Ask yourself: Am I accepting this earnout because I believe I'll hit the targets, or because I desperately want the deal to close? If it's the latter, be very careful.
Red flags: earnout represents more than 30% of total deal value; metric is EBITDA with buyer controlling all inputs; no cap on buyer expense allocation; no acceleration on platform sale; period exceeds 2 years.
Green flags: revenue-based metric; clear definition of metric with limited buyer discretion; earnout is 10–20% of deal value with reasonable targets; acceleration on sale; quarterly reporting rights.
→ How to Negotiate the Sale of Your Plumbing Business Full negotiation guide including deal structure terms → What Is a Purchase Price Adjustment? Working capital pegs and other post-close adjustments explainedAlso in the Lightning Path Guide Series
Own a HVAC business? See our companion guide: Earnout Structures When Selling an HVAC Business
DISCLAIMER: The information on this page is provided for general informational and educational purposes only. It does not constitute — and should not be construed as — financial advice, investment advice, legal advice, tax advice, or any other form of professional advice. Nothing on this site creates a professional advisory relationship between you and Lightning Path Partners. Business valuations, transaction structures, and market conditions discussed herein are general in nature and may not apply to your specific situation. Always consult a qualified financial advisor, M&A attorney, business broker, or CPA before making any business or financial decisions. Full Terms of Use →
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