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Earn Your Way out of Your Business

A business earn out pays an owner for their business over time

Weigh the benefits and the risks of accepting an earn out for your business

Anyone who has ever purchased or sold a home is familiar with the concept of ‘closing’. That is the process by which the buyer, seller and any intermediaries essentially sit around a table, sign documents exchange money, keys and transfer ownership from one party to the next.

Despite the minor hiccups that may occur, it’s a relatively cut and dry exercise. The new owners hand over a big check, get the deed and the keys to their new home, the sellers cash out, pack up the moving van and begin a new chapter in their lives. Contact between the parties is limited after this exiting event, if completely non-existent.

A major misconception about selling and exiting a business is that it is similar to purchasing a car or a house. Very rarely is the closing on a business a singular event like the example cited above. Exiting a business is not as simple (oh if only!). In many cases, especially with small businesses and professional practices the ‘closing’ is anything but a one time, final event that marks the complete transfer of capital and ownership from party to the other.

It is frequent the case that an exiting owner(s) may be attached at the hip to the new owners throughout the earn out period.  They may not be fortunate or even able to sell their business in a cash deal similar to the closing on a residential property. They may not have been able to reap the benefits of a growth strategy that will only reap benefits in the future. Or they may not want to leave all these future profits on the table for the new owner to haul in. In an earn out the exiting owners essentially earn their way out of their business in a variety of methods, either with an employment contract, consulting arrangement or royalty/commission stream on products and services.

Creating an earn out exit option can be a win-win scenario for all parties.  It is critical though that each side do their homework and have honest and frank discussion on area of responsibility and authority, the length of the earn out period and address the key ‘what-if’ situations that inevitably crop up. Their objectives aligned for mutual success. An earn out is one such example in which both parties have a vested interest in the continual growth of the existing business. The sellers take the risk of extracting their business wealth over time. The new owners get the benefit of having the exiting owners continuing to have a vested interest in the growth and success of the company they are selling.

The key point is that many business owner will never be able to exit their business and extract their business wealth in the same manner as a real estate transaction. They should prepare to stay connected both emotionally and perhaps physically to their business for an extended period.

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