To bridge a gap in our valuation, the buyer is offering us a choice between a two million dollar earnout over three years or a two million dollar seller note over five years. How do we evaluate the operational risks of these two choices to protect our money?

Question

Tyler Smith · Accepted Answer

When choosing between an earnout and a seller note, you are choosing between performance risk and credit risk. An earnout requires you to hit future financial targets to get paid. This is highly risky because once the deal closes, you lose absolute control of the business. The buyer could change the marketing budget, reallocate resources, or integrate your delivery team, making it impossible to hit your earnout metrics. A seller note, on the other hand, is a debt obligation that must be paid regardless of how the business performs, provided the company remains solvent. To protect your money, a seller note is almost always the superior choice, but you must structure it correctly. Insist on a market-rate interest payment, a stock pledge agreement that allows you to take back control of the company if they default, and restrictive covenants that limit the buyer's ability to take cash out of the business before your note is paid. If you must accept an earnout, make sure it is tied to gross revenue rather than net profit, as profit can easily be manipulated by the buyer's corporate overhead allocations. Use your V/TO® to decide if your leadership team is willing to stay engaged and fight for an earnout, or if a structured seller note better secures your clean exit.