The guide
The short answer
An earn-out is part of your sale price that the buyer pays after closing, and only if the business hits targets you both agreed, usually for revenue or profit. IBBA's Q2 2026 data put it at about 1% of deal value under $5 million. It is not allowed when the buyer uses an SBA 7(a) loan. If one is offered, ask how much of the result you still control.
What is an earn-out?
An earn-out is part of your sale price that the buyer pays after closing, and only if the business meets targets written into the contract.
This is an illustration, not a typical deal. A buyer offers $2,000,000: $1,500,000 at closing, and up to $500,000 more as an earn-out. The earn-out pays $250,000 for each of the next two years in which gross profit (sales minus the direct cost of making or delivering them) reaches an agreed figure.
| What happens after closing | What you receive in total |
|---|---|
| Both years hit the target | $2,000,000 |
| Year one hits it, year two misses | $1,750,000 |
| Both years miss | $1,500,000 |
So the "$2 million" offer is $1.5 million of price plus a bet worth up to $500,000, on a business you may no longer run.
How is an earn-out different from a seller note or cash?
A seller note is the buyer's promise to pay you part of the price later, with interest.
| Cash at closing | Seller note | Earn-out | |
|---|---|---|---|
| When you are paid | Closing day | In installments over months or years | After closing, once results are measured |
| The amount | Fixed | Fixed in advance | Unknown until the results come in |
| Who carries the risk | Settled once paid | You, if the buyer can't pay. See seller financing | You, and the buyer now controls what produces the result |
Why would a buyer ask for an earn-out?
The buyer is paying today for earnings they have not seen yet, and you disagree about how likely they are. An earn-out pays your price only if the business proves you right. It tends to come up for reasons like these:
- Customers. One customer is a third of revenue and may leave. See customer concentration.
- You. The customers know you and the prices are in your head. See how to make your business run without you.
- Growth claims. Last year was strong after weaker ones, and the buyer wants to see it repeat.
- Numbers they can't yet trust. The buyer's accountant hasn't accepted all your add-backs, the personal or one-off costs added back to profit.
A request for one is not a verdict on you. It shows a gap between your view and the buyer's, and the earn-out puts a price on it.
How common are earn-outs in small deals?
Not very, by value. The International Business Brokers Association (IBBA) and M&A Source Market Pulse for Q2 2026 charts how the price was paid in business sales up to $50 million. Shares from the chart:
| Business value | Cash at close | Seller financing | Earn-out |
|---|---|---|---|
| Under $500K | 88% | 11% | 1% |
| $500K to $1M | 92% | 6% | 1% |
| $1M to $2M | 91% | 7% | 1% |
| $2M to $5M | 84% | 9% | 1% |
| $5M to $50M | 83% | 6% | 7% |
These are averages of the share of the price, not a count of deals, so they don't show how many deals include one. Rows don't all add to 100%: in the $5M to $50M group another 4% was retained equity (the seller keeps a stake, often called rollover equity).
Can you have an earn-out if the buyer uses an SBA loan?
No. If the buyer is using a Small Business Administration (SBA) 7(a) loan to buy your business, seller earn-outs are prohibited. That is in the SBA's lender rulebook, SOP 50 10 8.1, in force since October 1, 2026. The rule does allow a rebate tied to how the business performs: money from you back to the buyer if results fall short. That money must go to paying down the loan.
So ask early how the buyer is paying. If it is an SBA loan, a seller note is still allowed, with conditions: see selling to a buyer with an SBA loan. The buyer's lender applies SBA's rules to your specific deal, and SBA revises its rulebook from time to time, so ask which version the lender is using.
How is an earn-out set up?
| Term | What to know |
|---|---|
| Measure | Revenue, gross profit or profit, often EBITDA (profit before interest, tax, depreciation and amortization). Sellers usually prefer revenue, which cost changes can't move. Buyers usually prefer profit, which they can move by changing costs after closing |
| Length | A longer period gives buyer decisions more time to change the result |
| Size | No standard share of the price. One test: would you sell for the closing cash alone? |
| Steps or cliff | Scaled as you near the target, or all or nothing at one number? Is there a cap? |
The law firm A&O Shearman's review of two deal studies, SRS Acquiom (2025) and the American Bar Association (2023), says revenue was the most popular measure, then earnings or EBITDA, and the median period outside life sciences was 24 months. Its examples include deals worth billions of dollars, so it is not about a $1 million sale.
Where do earn-outs go wrong?
After closing, the buyer usually runs the business, even if you stay on. The law firm Davis Wright Tremaine said in 2016 that buyers can find many ways to avoid paying: deferring revenue, restructuring the company, or putting other lines of business first until the period ends. Not every buyer does, but ordinary decisions can hurt the result too: a price cut to win volume lowers gross profit, and a merger with another business blurs the results.
The same article describes a 2015 Delaware Supreme Court ruling on an $80 million deal, half of it an earn-out tied to revenue. The agreement barred the buyer from acting to divert or defer revenue "with the intent of reducing" the earn-out. The court held that a buyer with reasons for its decisions other than avoiding the earn-out had not broken the clause, even if missing the target was the likely result.
What to settle before you agree to an earn-out
Take these questions to your lawyer. If you have a broker, ask what earn-outs they have seen in deals your size.
- The formula is written down with a worked example using last year's figures.
- The measure is defined, including which costs are in or out.
- The buyer keeps the accounting methods used to set the target, and any change is adjusted for.
- There are limits on buyer actions that cut the number. Check whether the wording tests intent or effect.
- You get regular figures and the right to review the books, with your accountant.
- You know what happens if the buyer sells the business. The Davis Wright Tremaine article says many earn-outs accelerate then, meaning the rest falls due.
- You know who stands behind the payment, and whether the buyer's lender allows it when cash is short.
- Your pay for any work you do after the sale is set separately from the price.
- Disputes have a named process: who decides, how fast, who pays.
How is an earn-out taxed?
Ask your CPA how this applies to you. A sale where you receive at least one payment after the year of sale is an installment sale, and you may be able to report the gain as payments arrive (IRS Publication 537), though inventory can't use that method and depreciation recapture (gain up to the depreciation you deducted) is reported in the year of sale. If the total price can't be fixed by the end of that year, as when the price includes a percentage of future profits (an IRS example), it is a contingent payment sale. Part of a later payment may be counted as interest, even if the contract doesn't call it interest, and interest is taxed as ordinary income, at regular rates.
If the earn-out depends on you staying on, part may be taxed as pay, not price. The law firm FBT Gibbons said in 2020 that past cases point to three guiding factors, not a fixed test: whether the earn-out period matches your employment, whether your pay is near market rate, and whether payments continue if your employment ends.
How can you make an earn-out less likely?
An earn-out fills the gap between what you say the business earns and what the buyer can verify. Small-business accounts are prepared for tax reporting, not to show a buyer the cash flow available to an owner. Recasting presents the same records in the way buyers and lenders assess them.
Three years of recast figures with each add-back documented leave the buyer fewer numbers to argue about. Records showing how long customers have stayed, and a business that runs without you, speak to two of the other reasons. None of this rules out an earn-out. It gives a buyer fewer reasons to ask.
What to do next
If you have an offer with an earn-out, work out two prices: the closing cash alone, and the cash plus the whole earn-out. If you could not accept the first, you are weighing a risk. Ask how the buyer is paying, then take the formula and checklist to your CPA and a business-sale lawyer.
If you are not at that stage, start with the recast: three years of earnings, every adjustment documented. Then read what a letter of intent contains before an offer arrives.
See where your business stands
Our free readiness score takes about ten minutes. Fourteen questions, scored the way a buyer would weigh them, with the three gaps most worth fixing. Nothing you enter is shared with anyone.
Keep reading
- Seller financing when you sell a business: how a seller note works
- Letter of intent to purchase a business: what's in it and what to negotiate
- Customer concentration: how much is too much when you sell?
This guide is general information, not tax, legal or valuation advice. Every business is different: talk to your accountant, lawyer and broker about yours.