When it comes to selling your business, many owners are surprised to find that an earn-out agreement is part of the deal. An earn-out often means part of the sale price is contingent on the business hitting specific targets after the sale, usually over several months or even years. But what if you could work your earn-out before you sell, keeping your exit clean and straightforward?
The good news is you can. By taking early, strategic steps to increase your business’s independence and appeal to buyers, you can achieve the full value of your business without having to stick around for post-sale performance targets. Let’s look at why earn-outs happen and, more importantly, how you can avoid them.
Why Earn-Outs Are Common in Business Sales
In many sales, an earn-out is the buyer’s way of securing their investment. They want reassurance that the business will continue to perform at the same level after you leave, so they require a portion of the payment to be contingent on post-sale performance. This makes sense from a buyer’s perspective; they want to protect themselves from unexpected revenue dips or client losses that might occur without the owner at the helm.
For the seller, however, this can create several problems:
- Delayed Payment: You won’t receive the full sale price upfront, making it difficult to reinvest or retire on your terms.
- Extended Involvement: You’ll likely need to stay involved in some capacity to achieve the required targets, which can limit your freedom post-sale.
- Buyer Control: Since part of your payout depends on performance, the buyer can make changes that impact outcomes, introducing a risk factor that’s out of your hands.
Avoiding the Earn-Out Trap by Working Your Earn-Out Now
The best way to avoid an earn-out is to “work your earn-out” before you sell the business. By preparing early, you make your business more attractive and reliable in a buyer’s eyes, reducing the need for performance-based contingencies. Here’s how:
1. Reduce Owner Dependence
One of the biggest red flags for buyers is a business that relies heavily on the owner. When buyers see that the current owner is deeply involved in daily operations or in revenue-driving roles, they worry about continuity. Start by building a management team, delegating responsibilities, and documenting key processes. A business that can operate smoothly without you will look more appealing and valuable, allowing you to exit without being tied to future performance.
2. Systematise Operations and Document IP
Having clear, repeatable systems and intellectual property (IP) in place can reassure buyers that your business has structure and stability. When operations are systematised and well-documented, it provides buyers with a blueprint for maintaining success post-sale. This consistency is valuable to buyers, who know they’re investing in a business, not just in the owner’s expertise.
3. Diversify Revenue Streams
If your business relies heavily on a few key clients, buyers may worry that the revenue stream could collapse without you. Diversify your client base to ensure no single client accounts for a disproportionate amount of revenue. A well-rounded portfolio of clients will make your business look stronger and less risky, reducing the likelihood of needing an earn-out arrangement.
Why Early Planning Pays Off
At Succession Plus, we guide clients through a 21-Step Exit Planning process that covers everything from financial planning to de-risking and operational improvements. This comprehensive approach helps you maximise the value of your business and ensures you’re fully prepared for a clean exit. With early planning, you have the time to address these key areas, giving you more control over the terms of your sale.
An early exit strategy not only helps you avoid the earn-out but also increases your business’s attractiveness and valuation. By the time you’re ready to sell, you’ll have built a business that can stand on its own—giving buyers the confidence to offer you a straightforward deal.
Key Takeaways
- Earn-Outs Are Avoidable: An earn-out isn’t inevitable if you start preparing early. Make your business less reliant on your presence and easier for a new owner to take over seamlessly.
- Systemise and Document: Well-documented processes and IP make your business reliable and consistent in the eyes of buyers.
- Diversify Your Revenue Base: Reduce the risk of revenue loss by broadening your client base, making your business look stable and secure.
If you’re thinking about selling, there’s no better time to get on the front foot. Start working your earn-out now by building a resilient, self-sustaining business, and leave when you choose, on your terms.
Ready to get started? Contact us to discuss how you can begin working your earn-out now and exit when you’re ready.
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