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Earn-outs pay out roughly 21 cents on the dollar, which makes the contingent slice of your purchase price the part that deserves the most scrutiny.

As someone who has sold a company and read a lot of letters of intent since, I stopped reading the headline number first. The number that decides your outcome is the one sitting underneath it, in the paragraph that starts with “subject to.”

That gap between the headline and the wire is where earn-outs live. Across private-target M&A deals tracked by SRS Acquiom, earn-outs pay about 21 cents on the dollar of their theoretical maximum. Roughly 59% of deals with an earn-out pay something at all, and among those that do, about half the maximum dollars get paid.

The friction is real too. Disputes surface in at least 28% of earn-out deals, and 17% of the deals that paid anything required a renegotiation to avoid litigation. So an earn-out is not a deferred payment. It is a contingent claim with a measurable discount and a meaningful chance of a fight.

None of that is an argument against earn-outs. It is an argument for pricing one honestly before you sign. If a buyer offers $10 million with $3 million contingent, the market-implied value of that offer is closer to $7.6 million, not $10 million. Sellers who skip that math negotiate hard over a number they were never going to receive.

This post covers what an earn-out actually is, what the current benchmarks look like, how the structures work in practice, how seller notes solve a different problem, and how the two get combined in real deals. It also covers the SBA rule changes that quietly rewrote seller financing for anyone selling to a buyer with a 7(a) loan.

What an Earn-Out Actually Is

An earn-out is a contractual promise to pay part of the purchase price later, only if the business hits agreed performance targets after closing. The buyer protects against overpaying for growth that has not happened yet. The seller keeps a claim on the valuation they believe is real.

It shows up most often in lower middle market deals, roughly $2 million to $50 million in enterprise value, where customer concentration, forecast growth, or integration risk create honest disagreement on price. Two reasonable parties can look at the same small business valuation and land $2 million apart. The earn-out converts that argument into a wager on the operating plan.

The mechanic that matters is who keeps score. Once the deal closes, the buyer controls the accounting, the cost structure, and the strategy that produces the number your payment depends on. That single fact drives every negotiating point in the rest of this post.

What the 2026 Earn-Out Benchmarks Say

Earn-out use has climbed back toward its long-run range after a volatile stretch. SRS Acquiom’s 2026 study, covering more than 2,300 private-target transactions closed through 2025, found earn-outs in 24% of deals, up from 22% in 2024 and above the historic average near 20%. Median earn-out potential also rose, reaching 34% of the closing payment against 31% the year before.

Smaller deals use them more aggressively. In the lower middle market data, 29% of deals up to $50 million carried an earn-out, rising to 35% for deals up to $25 million. If your business sits in that range, assume the buyer opens with one.

Duration clusters short, which is good news for sellers. Market practice skewed toward one to two years at 38% of deals, with 23% landing at a year or less and 20% in the two to three year band. Longer periods introduce more variables you cannot control and more integration decisions that muddy the measurement.

How Earn-Outs Get Structured

Most earn-outs come down to four design choices, and the metric is the one worth fighting over. Everything else is negotiable at the margin. The metric determines whether you are measuring something the buyer can move.

The Metric

Revenue is the seller-friendly choice and the most common one, appearing in roughly 62% of earn-out deals against about 22% for EBITDA. Revenue sits at the top of the income statement, above every allocation decision a new owner might make. That position is exactly why sellers want it and buyers resist it.

EBITDA hands the buyer a long list of levers. Corporate overhead allocations, new hires, marketing pullbacks, and one-time charges all move the number you get paid on. If you agree to an EBITDA earn-out, define the permitted adjustments inside the agreement rather than leaving them to post-close judgment, because what buyers accept as an add-back turns out to be far narrower than what sellers assume.

Non-financial metrics show up less often: gross profit, customer retention, new logos, regulatory approvals, or product milestones. These work when they are objectively measurable and sit outside the buyer’s discretion. They fail when somebody has to exercise judgment about whether the milestone happened.

The Formula

Three formulas cover most deals. A threshold structure pays a fixed amount once performance crosses a line, for example $1.5 million if 2027 revenue exceeds $12 million. A sliding scale pays a percentage of performance above a base, such as 30% of EBITDA over target, almost always capped.

A linear payout between a floor and a ceiling is the fairest of the three for a seller. Threshold structures create cliff risk, where missing the target by 2% costs you the entire payment. If the buyer insists on a threshold, negotiate a partial payment band underneath it so a near miss is not a total loss.

Timing and Caps

Payments are typically calculated annually and released after year-end financials are final, which in practice means 90 to 120 days after the period closes. Nearly every deal caps the buyer’s total exposure, and that cap is where the negotiation over upside actually happens.

Some agreements include a catch-up provision, so strong performance in year two can recover a shortfall from year one. It costs the buyer nothing in a good outcome and it is worth asking for every time.

Operating Covenants

This is where sellers leave the most money. Push for language requiring the buyer to run the business in the ordinary course, use commercially reasonable efforts to achieve the targets, maintain separate books for the acquired entity, and deliver monthly or quarterly reporting with audit rights attached.

Buyers resist broad restrictions for a legitimate reason, which is that they bought the company to integrate it. The workable compromise is specific rather than general. No reallocation of corporate overhead into the earn-out entity, no discontinuation of named product lines, no reassignment of the named sales team. Vague “reasonable efforts” language is what produces that 28% dispute rate.

Deal structure interacts with all of this. Whether you are doing an asset purchase or an equity purchase changes which entity the earn-out is measured against and how cleanly you can require separate books.

Seller Notes Solve a Different Problem

A seller note is debt, not a bet. The buyer pays part of the price over time under a promissory note carrying interest, and the obligation does not flex with how the business performs after you hand over the keys.

Seller financing is the standard at the small end of the market, not an exception. IBBA Market Pulse data puts it in 75% to 90% of transactions under $5 million and 40% to 60% of deals between $5 million and $50 million. Typical size runs 10% to 30% of total consideration, on terms of three to seven years, with interest commonly in the 5% to 9% range depending on deal size and perceived risk.

The two sides usually want very different amounts, which is the real negotiation once someone says the words “seller note.” Buyers push for 30% to 40% seller financing. Most sellers stay comfortable in the 10% to 20% range, and that spread is where deals stall.

There is also a tax reason sellers sometimes prefer paper to cash. Installment sale treatment under IRC Section 453 lets you spread the gain across the years you actually receive payments instead of recognizing it all at closing. Several asset classes are excluded from that treatment, so confirm it with your CPA before you price it into the deal.

Because the obligation is contractual debt rather than performance-based consideration, your legal position is stronger if the buyer stops paying. Recovery still depends entirely on what secures the note. An unsecured, subordinated seller note sitting behind a bank facility is a polite way of saying you are last in line, and pricing the interest rate as if it were senior debt is a mistake. This is the same debt versus equity tradeoff founders weigh on the way up, pointed in the other direction.

The SBA Rules That Reshaped Seller Financing

If your buyer is financing with an SBA 7(a) loan, and 78% of buyers in BizBuySell’s Q2 2026 survey said they expect to, the rulebook changed underneath everyone in June 2025 and the effects are still working through live deals.

SOP 50 10 8 reinstated a mandatory 10% equity injection for full changes of ownership, ending the window in which zero-down acquisitions were viable. A seller note can count toward that injection only if it sits on full standby for the entire life of the SBA loan, typically ten years, and it can cover no more than half of the required injection. Full standby means exactly what it says: no principal and no interest until the SBA loan is repaid.

The practical response is to split your paper into two notes. A small note carries the equity injection role and absorbs the ten-year standby. A second, larger note sits outside the injection calculation and can carry ordinary payment terms with a much shorter standby period. If your LOI shows a single seller note against an SBA-financed buyer, that structure is probably costing you years of payments for no reason.

One more rule matters specifically for this topic. SBA guidelines generally prohibit earn-outs and contingent purchase price in 7(a) transactions. If your buyer is an individual operator buying a business rather than starting one, the earn-out conversation may be off the table entirely, and the seller note becomes the only bridge available to close a price gap.

Earn-Out vs. Seller Note: A Side-by-Side Comparison

The two tools get discussed as if they are variations on the same idea. They are not. One transfers performance risk to you and the other transfers credit risk, and those require completely different protections.

Plenty of deals use both. A meaningful cash payment at closing, a modest seller note for certainty, and a smaller earn-out for genuine upside is a defensible structure. The failure mode is a thin cash close propped up by a large earn-out, which is a buyer transferring risk while keeping the headline price intact for the press release.

How to Price the Contingency Before You Sign

Model the earn-out at zero first. Not because it will pay zero, but because roughly two in five pay nothing and that is the base rate you are betting against. Once you know what the deal looks like in that scenario, everything else is upside you can negotiate calmly.

• Run three cases and apply the haircut. Realistic, optimistic, and pessimistic, then discount the headline earn-out to about 21% and compare offers on that basis. A $9 million offer with no contingency frequently beats an $11 million offer with $4 million at risk.
• Prefer revenue metrics and shorter periods. Twenty-four months or less keeps the measurement close to the business you actually built.
• Buy information rights. Monthly or quarterly reporting, defined calculation methodology, and audit rights with a dispute resolution mechanism. Without them you are relying on the buyer’s arithmetic and their goodwill.
• Define every adjustment in the document. If the agreement says “adjusted EBITDA,” the adjustments belong in a schedule, not in a future conversation.
• Price the seller note as credit risk. Interest rate, security interest, personal guarantee, and subordination position all need to reflect the fact that you are now this buyer’s lender.
• Assume your influence goes to zero at closing. Any protection that depends on you still being in the room needs to be written down instead.
• Hire counsel who does this weekly. Earn-out and seller-note language is where deals quietly succeed or fail in the two years after everyone shakes hands.

The scale of the business matters here too. Larger companies are harder to sell partly because the buyer pool shrinks and the structures get more contingent, so the same earn-out that reads as reasonable on a $5 million deal can carry very different risk on a $30 million one.

Price the Deal Twice Before Your Next Buyer Call

Take your current offer and value it two ways. Once at the headline number, and once with every contingent dollar discounted to what the data says it is actually worth.

If the second number still clears your financial freedom number, you have room to trade structure for certainty and negotiate from a position of strength. If it does not, the problem is the price rather than the earn-out language, and no amount of covenant drafting is going to fix that. Better to learn it now than 24 months after the wire hits.