Understanding Deal Structures: Earnouts, Equity Retention, and More

When selling a small business it’s easy to focus on just one number – the final sale price. But how a deal is structured is just as important as how much it’s worth on paper. A high sale price spread across risky or delayed payments may be less favorable than a slightly lower offer with more cash upfront and better terms.

If you’re considering selling your business, understanding common deal structures, like earnouts, seller financing, equity retention, and holdbacks, can help you evaluate offers more strategically and land on a transaction that best matches your goals in completing a sale.

What Is a Deal Structure?

A deal structure outlines the financial and legal terms under which a business is sold. It includes:

• How much of the sale price is paid upfront

• Whether any of the price is contingent on future performance

• What liabilities or assets are included

• How risks are shared between the buyer and seller

While the structure depends on the buyer’s preferences, the business’s risk profile, and your goals as a seller, most small business sales include a mix of cash at close, performance-based payouts, and retained interest.

1. Earnouts: Tying Payment to Future Performance

What is an Earnout?

An earnout is a portion of the purchase price that is paid only if the business meets certain performance goals after the sale. Typically, earnouts are tied to revenue or profit targets.

For example, you might agree to receive $1 million upfront and an additional $250,000 each year for three years if the business hits certain revenue milestones.

Why Earnouts Are Used

Earnouts help bridge valuation gaps when the buyer and seller desire to complete a transaction but may be stuck on a key term or struggle to find common ground related to transaction risk. Examples can include:

• A business that relies heavily on the current owner’s relationships

• Future growth is projected but unproven

• Concentration with a key customer requires earnouts tied to retention

Pros and Cons

Pros:

• You could receive more cash for the business if targets are met

• Helps get to transaction close despite valuation gaps

Cons:

• Future payouts depend on the business running well post-close

• Disputes can arise over how performance is measured

  
  

2. Seller Financing: Becoming the Bank

What is Seller Financing?

In this structure, the buyer pays a portion of the price upfront and signs a promissory note to pay the rest over time, typically with interest.

For example, a $500,000 sale might involve $300,000 upfront and $200,000 paid over five years at 6% interest.

Why It's Used

Seller financing is often used when:

• Buyers can’t secure full financing from a bank

• Sellers want to expand the pool of potential buyers

• Sellers trust the business will continue performing well

Pros and Cons

Pros:

• Generates passive income through principal and interest payments

• Allows you to close faster and generate interest from a broader audience

Cons:

• Risk of default

• Possibility of repossession of the business if operations take a negative turn

3. Equity Retention: Maintaining a Stake in the Business

What is Equity Retention?

In some deals, the seller keeps a minority ownership stake in the business post-sale, ranging from single digit percentages up to 20% or more.

This is common in cases where:

• The buyer values your continued involvement

• There is potential for rapid growth

• You're selling to a private equity or investment group

Why It’s Used

Retaining equity aligns interests: you help the business succeed and share in the upside if it does. It’s often used as a compromise between a full sale and staying on as the operational leader of the business.

Pros and Cons

Pros:

• Share in future growth or second exit

• Build trust with buyers through skin in the game

Cons:

• Less control over how the business is run

• Liquidity is delayed — you may have to wait years for a second payout

4. Holdbacks and Escrows: Protecting the Buyer

What Are Holdbacks and Escrows?

These are mechanisms through which a portion of the sale price is withheld temporarily to cover potential post-sale issues, such as undisclosed liabilities, tax debts, or warranty claims.

• Holdback: The buyer holds back part of the payment for a defined period.

• Escrow: Funds are held by a neutral third party (escrow agent) and released based on agreed conditions.

Why They're Used

Buyers want assurance that what they’re buying is as represented during diligence. Holdbacks reduce risk and ensure the seller remains accountable.

Pros and Cons

Pros:

• Builds trust and can make a deal more attractive to buyers

• Often a small percentage of the total deal (10–15%)

Cons:

• Ties up a portion of your payout

• Disputes over release terms can delay payments

5. All-Cash Deals: Rare but Clean

What is an All-Cash Deal?

In an all-cash transaction, the buyer pays the entire purchase price upfront with no earnouts, seller financing, or equity retention.

Why It's Rare

Few small business buyers can afford to pay entirely in cash, nor do buyers find the risk associated with a 100% cash deal to be acceptable. These deals are usually reserved for lower-risk businesses with clean financials and strong cash flow.

Pros and Cons

Pros:

• Immediate liquidity

• No ongoing involvement or future risk

Cons:

• May fetch a lower price compared to structured deals

• Limited pool of buyers

Which Deal Structure Is Best for You?

There’s no one-size-fits-all answer. The ideal deal structure depends on:

• Your risk tolerance

• Need for liquidity

• Trust in the buyer

• Desire to stay involved post-sale

• Tax implications

Often, transactions will combine structure elements, such as a deal that has partial seller financing, plus an earnout and rolled equity. Structure is useful for helping you meet financial goals while giving the buyer confidence in the transaction.

Prepare and Set Goals so Structure Can Increase Closing Odds

Understanding the building blocks of deal structures gives you more control and leverage during negotiations. Whether you’re selling for retirement, reinvestment, or a lifestyle change, the terms of the deal will shape your financial future and impact the chance that your deal is completed.

Before starting the sale process, think carefully about your transaction goals to help narrow the pool of candidate buyers and structures. A well-structured deal is not just about price — it’s about value, security, and leaving your business in a favorable position for continued success.

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