Selling a Business: How to Close the Valuation Gap
17 August 2026
One of the most difficult aspects of selling a business is getting the buyer and seller to agree on what the company is worth.
In last week’s post, we tackled the not unheard of situation of a business landing a potentially very lucrative project while the business is on the market and in discussions with potential buyers. The question then was, how does this new development impact the business’ value – and more important, how can we get the parties to agree on that revised value?
One of the solutions discussed was an earn out.
That post received a number of questions and comments so this post goes into more detail.
Sellers naturally look at what they have built, the company’s growth potential and what they believe the business will earn in the future. Buyers tend to be more cautious – if not suspicious. They are being asked to invest their money today based, at least in part, on results that may or may not materialize tomorrow.
That difference in perspective becomes even more pronounced in a subdued M&A market, where buyers are looking for favorable opportunities while interest rates are still elevated and more and more sellers are coming to market. In fact, our experience suggests that many sellers still have in mind the peak valuations of 2021-2023.
One increasingly common way to bridge that valuation gap is the earn-out.
What Is an Earn-Out?
An earn-out is simply case where a portion of the business’ purchase price is paid after closing, provided the business achieves certain agreed-upon results.
For an extremely elementary example, a buyer and seller might agree that the business is worth $5 million if it achieves a certain level of EBITDA over the next two years. Rather than asking the buyer to pay the entire $5 million at closing, the transaction might provide for $4 million upfront, with another $1 million payable if the company reaches the agreed performance target.
We offer a comprehensive coaching program – both group and 1:1 options – in The Brokers Roundtable℠, our online support platform tailored for business owners, business brokers, Realtors, buyers and anyone else interested in valuing, buying or selling a business.
The performance measurement does not necessarily have to be Discretionary Earnings (or EBITDA). Earn-outs can be tied to revenue, profit, gross profit, operating cash flow or other financial measures. They can also be based on milestones such as launching a new product, obtaining a patent, completing a major project or onboarding an important customer.
The earn-out period will vary by transaction, but two to three years is often preferable. Longer periods can become increasingly difficult for both sides because the business, economy and competitive environment may change significantly.
Why Buyers and Sellers Use Earn-Outs
The primary purpose of an earn-out is to bridge a disagreement over value.
Suppose a seller says, “Based on our growth, this business will generate $1.5 million in EBITDA next year.”
The buyer responds, “Maybe. But right now, it generates $1 million, and I’m not willing to pay today for earnings that haven’t happened yet.”
An earn-out provides a possible solution: If the seller is right, the seller gets paid for that growth. If the buyer is right, the buyer hasn’t overpaid for performance that never materialized.
That risk-sharing is the fundamental appeal of the earn out concept. Buyers reduce the amount of capital at risk upfront, while sellers retain the opportunity to receive a higher overall purchase price if the business performs as expected.
Our video, on how the value of a business’ assets might add to the value of a business, is HERE on our YouTube channel.
The Devil’s in the Details
While the concept is simple, drafting a good earn-out agreement is not.
One of the biggest questions is exactly how performance will be measured. If the earn-out is based on adjusted EBITDA, for example, the agreement needs to define adjusted EBITDA very carefully.
Why?
Because after closing, the buyer generally controls the company. Decisions involving compensation, staffing, marketing expenses, corporate overhead, accounting assumptions and other expenses could influence the earnings used to calculate the seller’s earn-out.
Even companies following generally accepted accounting principles still make management judgments that can affect reported results. In a case where the earn out is based on a minimum increase in EBITDA, the business’ revenue could increase 20% but the reported earnings remain flat as a result of the buyer decision to hire a sales team and expand marketing efforts.
Such potential makes it essential that the purchase agreement clearly specifies the accounting assumptions and calculation methodology that will be used.
___________________________________________________________________________________________________
REALTORS! Our course, “Learn How to Value and SUCCESSFULLY Sell Businesses“, teaches you how to value and sell businesses.
Don’t Miss Out on the Coming “Silver Tsunami”!
Sellers should also negotiate appropriate information and control rights so they can determine how the business is performing during the earn-out period. The agreement should address how disputes will be resolved, what issues may be referred to an independent expert and when litigation or another dispute-resolution process may be necessary.
The objective is to eliminate as much ambiguity as possible before the transaction closes.
The Advantages—and Risks
Earn-outs offer several important advantages. Payments can be staggered, reducing the buyer’s initial cash requirement – and the seller’s tax liability. Risk is shared between the parties, and the seller can participate financially in future growth.
But there are disadvantages.
The seller may need to remain involved with the business longer than originally anticipated. And if performance falls short, the seller may receive substantially less than expected. Earn-outs also make negotiations more complicated and create another potential source of post-closing disputes.
Check out our video series, “How Much is My Business Worth“ on our YouTube channel.
There can also be significant accounting and tax consequences for both parties depending on how the earn-out is structured and whether the seller continues working for the company. In particular, payments intended as additional purchase price can potentially be treated differently if they are effectively tied to the seller’s continued employment or services.
For that reason, the tax and accounting treatment should be reviewed by qualified professionals before the agreement is finalized.
The Bottom Line
An earn-out should not be viewed as a way to avoid deciding what a business is worth. Instead, it is a way to deal with genuine uncertainty about future performance – and disagreement between the parties.
When a seller believes strongly in the company’s growth prospects and a buyer is unwilling to pay upfront for results that have not yet occurred, an earn-out can provide the bridge that gets the transaction done.
But the simpler and more objective the formula, the better.
Clearly define the performance targets. Clearly define how they will be calculated. Establish the earn-out period. Determine what information the seller will receive – and how much impact he or she will have on the decisions that are likely to impact the company’s performance. And decide in advance how disagreements will be resolved.
Done properly, an earn-out can turn a valuation disagreement that might otherwise kill a transaction into a structure both sides can accept. Done poorly, it can simply postpone the argument until after closing.
“Try not to become a man of success. Rather become a man of value.””
– Albert Einstein
If you have any questions or comments on this topic – or any topic related to business – I’d like to hear from you. Put them in the comments box below. Start the conversation and I’ll get back to you with answers or my own comments. If I get enough on one topic, I’ll address them in a future post or podcast.
I’ll be back with you again next Monday. In the meantime, I hope you have a safe and profitable week.
Joe
Searching For…
NOTE TO READERS: Our “Searching For…” feature has been moved to our online community, The Brokers Roundtable℠. It will appear there exclusively from now on.
#business #businessacquisition #sellabusiness #becomeabusinessbroker #businessbrokering #businessvaluation #MergersandAcquisitions #buyabusiness #sellabusiness #realtor #realestateagents
The author is the founder of Worldwide Business Brokers and holds a certification from the International Business Brokers Association (IBBA) as a Certified Business Intermediary (CBI) of which there are fewer than 1,000 in the world. He can be reached at
