"We'll pay you $2 million at closing, plus up to $500,000 over the next two years based on performance." If you're selling your home care agency, there's a good chance you'll encounter an earnout structure like this. Earnouts are increasingly common in healthcare M&A, and understanding how they work, and how to negotiate them. can significantly impact your total proceeds.
According to the Harvard Law School Forum on Corporate Governance, earnouts appear in roughly 37% of M&A deals as of 2023. In healthcare, the percentage is even higher due to the complexity of valuing businesses with regulatory and reimbursement uncertainty. This guide explains how earnouts work, when they make sense, and how to protect yourself.
What Is an Earnout?
An earnout is a portion of the purchase price that's contingent on the business achieving certain targets after closing. Instead of receiving all cash at closing, you receive some amount upfront and additional payments if specific milestones are met.
Example Earnout Structure
| Component | Amount | Timing |
|---|---|---|
| Cash at Closing | $2,000,000 | Day 1 |
| Year 1 Earnout (if EBITDA ≥ $500K) | $250,000 | Month 15 |
| Year 2 Earnout (if EBITDA ≥ $550K) | $250,000 | Month 27 |
In this example, the total potential consideration is $2.5M, but only $2M is guaranteed. The remaining $500K depends on hitting EBITDA targets.
Why Buyers Use Earnouts
Bridge Valuation Gaps
When buyer and seller disagree on value, an earnout converts the disagreement into a bet on future performance. If the seller is right about growth potential, they'll earn the earnout. If the buyer is right to be cautious, they pay less.
Reduce Risk
Earnouts protect buyers from overpaying if the business underperforms post-acquisition. They're particularly common when there's uncertainty about client retention, referral relationships, or regulatory changes. Private equity buyers frequently use earnouts in their deal structures.
Align Incentives
Earnouts keep sellers motivated during the transition period. If you have money on the line, you're more likely to support the buyer, maintain relationships, and ensure a smooth handoff.
Common Earnout Metrics
| Metric | Seller Preference | Buyer Preference | Notes |
|---|---|---|---|
| Revenue | Preferred | Less preferred | Top-line, harder to manipulate |
| EBITDA | Acceptable | Preferred | Common compromise, but subject to expense allocation |
| Client Retention | Caution | Preferred | Specific, but seller has limited control post-close |
| Referral Retention | Caution | Preferred | Addresses concentration risk, but relationship-dependent |
Protecting Yourself in Earnout Negotiations
Negotiate Post-Closing Covenants
The buyer will control the business after closing. Without protections, they could make decisions that hurt your earnout. cutting marketing, raising prices, or reallocating resources. Key covenants to negotiate:
- Operate business consistent with past practice
- Use commercially reasonable efforts to achieve earnout
- Maintain minimum working capital levels
- Run target as stand-alone entity for earnout period
- Maintain separate books and records
Define Metrics Precisely
Ambiguity leads to disputes. Ensure the purchase agreement defines exactly how earnout metrics will be calculated, what expenses are included/excluded, and how disputes will be resolved. Consider using an independent accountant for calculations.
Negotiate Acceleration Provisions
What happens if the buyer sells the business before the earnout period ends? Or merges it with another company? Negotiate acceleration provisions that pay out the earnout (or a portion) if certain events occur.
Prefer Shorter Earnout Periods
The longer the earnout period, the more can go wrong. According to the SRS Acquiom 2025 M&A Deal Terms Study, the industry median is 24 months for non-life sciences deals. Push for 12-18 months if possible. Longer periods increase uncertainty and your exposure to factors outside your control.
Warning: Earnouts Often Lead to Disputes
As Vice Chancellor J. Travis Laster of the Delaware Court of Chancery noted: "An earn-out often converts today's disagreement over price into tomorrow's litigation over the outcome." Earnout disputes are common and expensive. The best protection is clear documentation, reasonable metrics, and strong post-closing covenants.
The Bottom Line: Earnouts Can Work, But Be Careful
Earnouts aren't inherently bad. They can help bridge valuation gaps and get deals done. But as the SRS Acquiom M&A Claims Insights Report documents, earnouts pay about 21 cents on the dollar across all deals, meaning they shift significant risk to you, the seller. Make sure you understand exactly what you're agreeing to, negotiate strong protections, and have realistic expectations about achievability.
When evaluating an earnout offer, ask yourself: Would I be satisfied with just the guaranteed portion? If the answer is no, you may want to negotiate harder on the upfront amount or walk away.
Understand Your Negotiating Position
The stronger your agency's fundamentals, the more leverage you have to negotiate favorable earnout terms, or avoid them entirely. Use our exit timeline calculator to plan your approach.