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Things I would do differently in an earnout (or it is earn out?)

For the sake of this article I'm going to assume it's earnout.


The concept of an earnout is great. Someone buys your business and pays you some money for it. Plus, they then offer to pay you some more money if the business keeps growing. And in general the person buying your business will have bigger clients, bigger budgets, bigger infrastructure so additional growth should be easy.


Where the concept fails slightly, is that it's difficult to motivate someone with money after you've just given them a lump of it. The impact that money has on your life will be significantly higher from £0 million to £5 million for example, than £5 million to £10 million.


Of course there have been many successful earnouts in history, but I would guess probably a lot more not-quite-successful ones too.


I would describe my own earnout as semi-successful. So I wanted to share some thoughts on how I could make it more successful if I was lucky enough to have the opportunity again.


Before I list a few points to consider, I really want to hammer home my main bit of advice for anyone considering a deal with an earnout. Make sure you are happy with day one money.


Sept 22 2021 was day one of my earnout


Reverse due diligence

You'll be pushed to find a acquisition that goes through without some element of due diligence. Usually this involves the buyers, or an army from the likes of PWC, to spend weeks drilling through every contract, client and breathe that you've had over the previous years. Understandably looking for any evidence that could cause exposure down the line, or lifts the lid on some untruths in the way the acquired business has been portrayed.


But, it's much more rare for the acquiree to do some level of due diligence on the business that's buying it. The reason is obvious. The founders of the businesses being acquired are so deep in calls, meetings and requests, as well as having one eye on the prize at the end, that they don't want to think of anything that might make the deal fall down. This is very normal, and I give this advice as someone that didn't do it at the time, but think it would have been useful.


I'm sure your lawyers and advisors will do the very basic reverse due diligence of just checking the business has sufficient funds etc to pay the price they have offered, but you as the founder could maybe explore some of the areas that will impact you most as you effectively become an employee again for the next period of your life.


Your business will be getting bought based on some core metrics. This might be revenue, growth, EBITDA, client satisfaction or many other things. Make sure you check what the acquiring businesses core metrics are too. For example, you might be a rocket ship with high revenue and growth but low EBITDA. So you might get an earnout based on continued growth. But if the business that's buying you is much bigger with minimal growth, you might find that they are all about the EBITDA. You may find that from day one your priorities conflict with the wider business and find yourself needing to justify costs or investments that you wouldn't have to as an independent business.


Length

We had 13 acquisition approaches during our journey at Molzi and the proposed earnouts ranged from 1 year to 5 years. The longer earnouts were pitched as giving me more time to realise further value from the sale. But have a think about what you are likely to actually want from life after the acquisition. On the assumption that you've just made a life changing amount of money on day one, do you really want to be an employee for someone else's business for another 5 years, just for a bit more money? If you're a founder, the likelihood is that you'll already be thinking of the next projects, and now you have resource to put behind them. So just take time to consider how long you really want to hang around for inside your business that's no longer yours.


Independence

I would guess that one of the main reasons your business has been successful enough to be acquired is because of the speed at which you make decisions. It's the super power of the startups and the reason why larger organisations have to keep buying companies rather than just doing things themselves. Large companies in general are slow. They might not seem slow if you work inside them as an employee. But if you go from a startup, it'll be like that feeling when you go from the hot tub back into the swimming pool.


Lack of speed can kill a businesses momentum, so make sure you check with any acquirers what restrictions there will be on sign offs of costs, what access to data there will be and whether you can continue to operate as a separate entity within the bigger organisation.



These are just a few examples, but the general message is to try and forget about the golden egg at the end of the process just for a second, and just make sure that you will be given the very best chance to succeed. An earnout is a privilege that very few people get to be involved in, so it's worth spending a bit of time to get it right.



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