The Earnout Trap

Sat with a founder a while back, the week after he'd agreed to sell his agency. He was in good spirits. He'd negotiated what he thought was a fair deal.

I asked him what he was most looking forward to. He said freedom. Being able to do what he wanted, work on things he cared about, not be accountable to clients he didn't like.

I asked him to read the earnout clause again.

He was contracted to hit specific revenue targets for three years, under new management, with strategy set by the acquirer. He'd keep his title. He'd report to someone he'd never met. If he missed the targets, a significant portion of the sale price would not be paid.

That's not unusual. Earnouts are the standard structure in agency M&A. The acquirer pays a portion upfront and the rest over time, contingent on performance. It aligns interests, in theory. In practice it means the number on the term sheet is not the number you actually receive unless everything goes right for three years, in a company that is no longer yours, under a strategy you didn't set.

The way to reduce it — ideally to nothing — is to build the business so the acquirer doesn't need you to stay. Their risk drops, they can pay more upfront. It takes a couple of years to do properly, which is why it's worth starting earlier than you think.

This is the thing I'm famous for by the way. Creating a succession team inside 6 months, and releasing you to do the fun stuff. Like securing your freedom.

scorecard.felixvelarde.com — there's a section on how dependent your agency is on you.