SATURDAY | MIKE’S DESK
TL;DR: A seller refused to carry a standard note and pushed hard for an earnout instead. A buyer read that as flexibility. I read it as a forecast. An earnout pays the seller only if future numbers hit, which means the seller is quietly telling you the future is not guaranteed. After 35 years, I want to know why before I sign.
A seller note backs up the past. An earnout bets on the future. When a seller suddenly prefers the bet, pay attention to what that says about the past.
A buyer came to me excited because the seller had offered what sounded like generous financing. The seller did not want a traditional note. He wanted an earnout: a chunk of the purchase price paid out over the next two years, but only if the business hit certain revenue targets. The buyer thought he had found a flexible, motivated seller. What he had actually found was a seller telling him something important without saying it out loud.
A Note and an Earnout Are Not the Same Animal
People lump these together as seller financing, but they point in opposite directions. A seller note is the seller lending you money against a price you already agreed on. The seller gets paid back regardless of how the business performs, which means the seller is standing behind the value of what he sold you. That is skin in the game on the past. It is a vote of confidence in the business as it sits today.
An earnout is the reverse. The seller only collects the earnout money if the business performs to a target after you take over. On the surface that sounds like the seller has skin in the game on the future, and sometimes that framing is honest. But look at it the way the seller is hoping you do not. If a seller pushes an earnout instead of a note, one read is that he is confident in the future and happy to bet on it. The other read, and the one I have seen more often, is that he does not believe the current numbers are repeatable and wants to get paid full price only in the world where they magically hold.
What the Earnout Push Is Really Telling You
Here is the thing nobody mentions about earnouts. They quietly convert your purchase price into a forecast. Instead of paying a settled number for a business with a known track record, you are now agreeing that the business is worth the full price only if it grows or holds in your hands, under your management, in your first uncertain year of ownership. The seller has handed you the risk of hitting his number while keeping the upside if you do.
I worked with a buyer last year who hit this exact situation. The seller would not carry a dollar of standard paper but offered a rich earnout tied to revenue. We slowed down and asked the obvious question: if you believe these numbers, why not back them with a note? The answer came out sideways. A major contract was up for renewal in eight months and the seller was not certain it would renew. The earnout was not generosity. It was a way to collect full price if the contract stayed and walk away clean if it left, with the buyer holding the loss either way.
After 35 years of looking at these, I treat the financing structure a seller prefers as one of the most honest signals in the entire deal. A confident seller carries a note. A seller who wants an earnout is often telling you the past does not guarantee the future, and he would rather share your optimism than guarantee your downside. Neither is automatically disqualifying. But the difference tells you exactly where to point your diligence.
When the seller would rather bet on the future than guarantee the past, find out what he knows about the future that you don't.
Model both structures in DealScore Pro before you decide. Put in the deal with a seller note and watch the DSCR and your cash position. Then model the earnout and notice how your payments balloon in exactly the years the business is least proven under your ownership. Seeing the two side by side in 60 seconds usually settles the argument about which structure actually protects you.
A seller note says 'I stand behind what I sold you.' An earnout says 'let's hope it works out.' Those are different sentences.
How to Handle an Earnout the Right Way
Earnouts are not the enemy. They are a legitimate tool when a business is genuinely growing and both sides want to bridge a gap in price expectations. The key is to use them on your terms, not as a substitute for the seller standing behind his own numbers. If a seller insists on an earnout, push to keep a portion as a straight seller note, so he still has accountability for the baseline. Tie the earnout to metrics you control and can verify, not vague revenue that a single lost contract can torpedo. And never let the earnout payments stack into your first year, when the business is least proven in your hands.
The buyer who faced that contract-renewal seller restructured the whole deal. He cut the price to reflect the at-risk contract, took a real seller note on the lower number, and added a small upside-sharing bonus if the contract did renew. The seller got paid fairly. The buyer stopped carrying all the risk. Same deal, honest structure, and the renewal question moved from a hidden landmine to a line item both sides could see.
What This Means For You
If a seller steers you toward an earnout and away from a note, treat it as a flag worth investigating, not a perk. Ask what he is unsure about, point your diligence there, and restructure so he still stands behind his baseline numbers.
— Mike
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