Earnout vs seller note: which is better for you?
Both defer part of your money. One depends on future performance you may not control, the other is a debt owed to you. That distinction is worth a great deal.
Educational only. Not legal, tax, or investment advice.
Two ways to be paid later, with very different risk
Very few trade business sales are 100 percent cash at close. Buyers use deferred consideration to bridge valuation gaps, protect against surprises, and keep the seller engaged. The two most common instruments are an earnout and a seller note, and they are not equivalent.
What a seller note is
A seller note is a loan you make to the buyer for part of the purchase price. The buyer signs a promissory note with a stated principal, interest rate, and payment schedule, typically three to five years at a market interest rate. You are a creditor. The obligation exists regardless of how the business performs, and if the buyer stops paying you have contractual remedies.
What an earnout is
An earnout is a conditional payment tied to future performance. You receive an additional amount only if the business hits defined targets, usually revenue or EBITDA, over one to three years after close. If the targets are missed, you are paid nothing on that portion, and there is no debt to collect. The risk profile is fundamentally different.
| Profile | Typical EBITDA multiple | Notes |
|---|---|---|
| Seller note | Lower risk | A debt obligation with a fixed schedule. Paid regardless of performance. Negotiate security, and avoid full subordination to bank debt where possible. |
| Earnout | Higher risk | Conditional on hitting targets. Frequently paid at less than 100 percent because the buyer controls the levers after close. |
| Escrow or holdback | Moderate risk | Your money held to cover representation breaches. Usually 5 to 15 percent for 12 to 24 months. Negotiate size and release timing. |
| Rollover equity | Highest variance | Illiquid minority stake. Largest upside and the possibility of zero. See the rollover equity guide. |
Why the earnout usually favors the buyer
Because after close, the buyer controls almost everything that determines whether you hit your targets. They set pricing, marketing spend, technician pay, and hiring. They may allocate corporate overhead to your entity, which reduces EBITDA. They may integrate your operation into another branch so your results are no longer separately measurable. None of this needs to be deliberate to cost you the payment. Earnouts frequently pay at a fraction of the maximum, and the disagreements are a common source of post-close litigation.
If you accept an earnout, negotiate these six things
- Revenue, not EBITDA. Revenue is much harder to manipulate through cost allocation. If it must be EBITDA, define it precisely in the agreement, including which overhead can and cannot be charged.
- A short measurement period. One year beats three. The further out the target, the less your work explains the result.
- Sliding scale, not a cliff. Partial achievement should pay proportionally. All-or-nothing thresholds are where sellers lose everything by a few percent.
- Authority to match the responsibility. If you are accountable for the number, you need control over pricing, spend, and hiring in your operation.
- Separate accounting, in writing. Your business must remain separately measurable, with a defined method and audit rights, for the whole earnout period.
- Acceleration on change of control. If the buyer sells, reorganizes, or removes you, the earnout should accelerate and pay in full.
If you accept a seller note, negotiate these four
- Security. A personal guarantee, a lien on the assets, or a pledge of the equity you sold. Unsecured notes rely entirely on the buyer’s goodwill.
- Subordination limits. Buyers using bank debt will require your note to sit behind the lender. Push to limit the extent, and understand that full subordination means the bank is repaid first if anything goes wrong.
- A market interest rate. You are extending credit. A below-market rate is a quiet price reduction.
- Real default remedies. Acceleration on missed payments, and no right of offset that lets the buyer withhold payments over unrelated disputes.
The comparison that actually matters
Rank offers by risk-adjusted cash, not headline price. A 7x offer with 55 percent cash at close, 25 percent in a three-year EBITDA earnout, and 20 percent in an unsecured subordinated note is very likely worth less than a 6x offer with 90 percent cash at close and a 10 percent escrow. Discount earnout dollars heavily, seller note dollars moderately, and count only cash at close as certain. Then compare.
When an earnout is genuinely reasonable
Occasionally the gap is real. If your last year included an unusual spike, if you are mid-way through a genuine growth initiative, or if you are asking a buyer to pay for a projection rather than a track record, an earnout is a fair way to share that uncertainty rather than lose the value entirely. The distinction is whether the earnout bridges a real valuation question or simply moves risk onto you for a number the business already supports.
Deferred payment questions.
Is a seller note or an earnout better for the seller?
A seller note is materially safer. It is a debt obligation with a fixed schedule that must be paid regardless of business performance, and non-payment gives you contractual remedies. An earnout pays only if targets are met, and after close the buyer controls most of the levers that determine whether they are.
Why do earnouts so often pay less than the maximum?
Because the buyer controls the business during the measurement period. Pricing changes, marketing decisions, technician pay, allocated corporate overhead, and integration into another branch can all reduce measured performance without anyone acting in bad faith. That is why sellers should prefer revenue-based targets, short measurement periods, sliding scales, and separate accounting with audit rights.
How much of my price should be cash at close?
As much as you can negotiate, and typically 70 percent or more in a competitive process. Deals with strong fundamentals and multiple bidders often reach 85 to 90 percent cash with a modest escrow. If a buyer proposes less than half in cash, that is a signal to look at their financing and at whether other buyers exist.
What is a normal escrow or holdback?
Commonly 5 to 15 percent of the purchase price held for 12 to 24 months to cover breaches of representations and warranties. It is standard and not unreasonable. What is negotiable is the size, the release schedule, and whether specific known items are carved out or given their own separate indemnity.
Should I take a lower multiple for more cash at close?
Frequently yes. Cash at close is certain; deferred consideration is not. Discount earnout dollars heavily and seller note dollars moderately, then compare the risk-adjusted totals. A 6x offer paid almost entirely in cash regularly beats a 7x offer with a quarter of the price sitting in a three-year earnout.
Can I negotiate structure after signing a letter of intent?
Much less effectively. The LOI sets the framework, and once you are exclusive with one buyer your leverage drops sharply. Structure should be negotiated before the LOI is signed, which is another reason to have multiple interested buyers at that stage rather than one.
Negotiate structure from a position of knowledge.
Start with a free confidential valuation so you know what the business supports before terms are on the table.