We are would like to buy our first small business. The seller said that he is "open to an earn out." The company is a subchapter C corporation, but this issue came up in another deal where the business was organized as a California limited liability company (LLC). I would appreciate a business and finance explanation of an earn, not a legal description.
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There are a number of ways to structure earn outs as part of the purchase of a small company. Typically earn outs are used either to bridge a valuation gap between a buyer and a seller or as an incentive for an seller that also manages the firm to continue in their management capacity for a certain period after the sale (and often for both of these purposes). In most cases earn out payments are based on the target company's actual financial performance as compared to their projected performance at the time of the sale. For example, an earn out may be paid 3 years after the purchase of the company contingent upon the company achieving its revenue and/or EBITDA projections during that period (and it may require that the seller remain employed by the company until the time of payment).
There are many variations on the time horizon over which an earn out is measured, the various financial and other metrics they may be used to determine how much earn out is paid, and the associated employment requirements. Feel free to post additional specific questions on any of the more detailed earn out topics.