StarForge Advisors

LOI · with earn-out

LOI with earn-out

Adds a contingent earn-out to the standard asset-purchase LOI. Earn-outs bridge the buyer/seller gap on forward performance and align a retiring seller with post-close retention. They also create the most-litigated post-closing disputes in M&A — the LOI is the time to get the mechanics right.

Download DOCX LOI - With Earn-Out.docx

When to use this template

Earn-outs are common when:

  • The seller projects significantly higher forward EBITDA than the trailing TTM (the buyer's offer) supports.
  • The business has customer or vendor concentration where the seller's relationships materially affect retention.
  • The seller is staying on for a transition period and the buyer wants performance alignment.
  • A specific identifiable customer, contract, or revenue stream is uncertain (e.g., contract renewal in process).

The earn-out trap — and how to avoid it

Earn-outs generate more post-closing disputes than any other M&A provision. The recurring fight pattern: the buyer changes the business in a way that affects the earn-out metric (consolidates systems, shifts customer mix, changes accounting), the seller claims the change was designed to suppress the earn-out, litigation follows.

The defense is to be aggressive about specifying:

  • The metric. Revenue is harder to manipulate than EBITDA. EBITDA is harder to manipulate when "EBITDA" is defined to specific GAAP/tax-line items rather than a calculated value.
  • The accounting basis. Frozen at closing-date accounting policies, or evolving with the buyer's chosen policies post-close.
  • Operational covenants. What can the buyer change during the earn-out period without triggering a dispute? Customer mix, pricing, headcount, M&A?
  • True-up timing. Annual measurement, cumulative measurement, catch-up provisions.
  • Dispute resolution. Independent accountant, expedited process, no extended litigation.

Get these specified at the LOI level. Pushing them to the SPA risks fundamental disagreement after exclusivity has set in — at which point the seller has leverage and the buyer has sunk diligence costs.

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LETTER OF INTENT

Asset Purchase with Earn-Out — [TARGET BUSINESS NAME]

Date: [DATE]
Buyer: [BUYER ENTITY NAME]
Seller: [SELLER LEGAL ENTITY NAME]
Target: The business operated as [TARGET DBA]

1. Transaction structure

Asset purchase, with a contingent earn-out as set forth in Section 3.

2. Purchase price

Aggregate consideration is comprised of (a) closing-date Purchase Price and (b) contingent earn-out payments:

  • Closing-date Purchase Price: [$0,000,000], on a cash-free, debt-free basis, paid at closing
  • Earn-out: Up to [$0,000,000] additional, payable as specified in Section 3
  • Maximum aggregate consideration: [$0,000,000]

3. Earn-out terms

Measurement period: The Earn-Out will be measured over the [two/three] consecutive twelve-month periods immediately following the closing date (each, an "Earn-Out Year").

Metric: Earn-Out is based on [Revenue / Adjusted EBITDA] of the Business in each Earn-Out Year, computed in accordance with the closing-date accounting policies of the Business, frozen as of closing.

Payment schedule:

  • If [Metric] in an Earn-Out Year < [$ threshold 1]: no payment
  • If [Metric] in an Earn-Out Year ≥ [$ threshold 1] and < [$ threshold 2]: pro-rata payment between zero and the year's full earn-out
  • If [Metric] in an Earn-Out Year ≥ [$ threshold 2]: full earn-out payment for that year
  • Earn-out payments per year capped at [$ amount]; aggregate cap of [$ amount]

Catch-up: If [Metric] in a later Earn-Out Year exceeds the cumulative target through that year, the seller may catch up on previously-missed payments.

Operational covenants during the Earn-Out:

  • Buyer will operate the Business in a manner reasonably consistent with its operation prior to closing during the Earn-Out period, including maintaining the brand, sales channels, and core customer relationships.
  • Buyer will not (a) discontinue significant product lines that contribute to the Earn-Out Metric, (b) consolidate the Business with another buyer-owned operation in a manner that obscures the Earn-Out Metric, or (c) change accounting policies in a way that reduces the Earn-Out Metric, in each case without prior written consent of Seller (consent not to be unreasonably withheld).
  • Buyer is not obligated to operate the Business with the maximization of the Earn-Out as a goal; ordinary-course business decisions remain at Buyer's discretion.

Reporting: Within forty-five (45) days after each Earn-Out Year, Buyer will deliver to Seller a written statement of the Earn-Out Metric for that year, with reasonable supporting detail. Seller will have thirty (30) days to dispute the statement.

Dispute resolution: Disputes regarding the Earn-Out calculation will be submitted to a mutually-selected independent accounting firm (the "Independent Accountant"), whose determination will be final and binding. The Independent Accountant's fees will be split between the parties based on the proportion by which each party's position diverges from the determination.

4. Working-capital peg, earnest money, diligence, exclusivity

Same as standard Asset Purchase LOI.

5. Closing conditions

  • SBA 7(a) loan commitment
  • Diligence to Buyer's satisfaction
  • Third-party consents
  • No material adverse change
  • Execution of definitive APA with detailed earn-out exhibit

6. Confidentiality, expenses, governing law

Same as standard Asset Purchase LOI; confidentiality is binding on signature.

7. Binding provisions

Earnest Money, Exclusivity, Confidentiality, Expenses, and Governing Law are binding upon signature. All other provisions are non-binding.

Accepted and agreed:

BUYER: ______________________________
SELLER: ______________________________

Negotiation notes

  • Pick Revenue over EBITDA when you can. EBITDA-based earn-outs invite endless adjustment fights. Revenue is a cleaner metric — harder to manipulate, easier to measure, less prone to allegation that the buyer suppressed it. Sellers will resist Revenue because it ignores margin compression; that's part of the negotiation.
  • Define EBITDA precisely if you must use it. If the seller insists on EBITDA, point to specific GAAP line items: "Net Income + Tax + Interest + D&A as reported on the audited financial statements, with no further adjustments unless mutually agreed." Avoid loose phrases like "as customarily defined."
  • Cap the upside. Earn-outs without a cap are open-ended buyer liability. Always cap.
  • SBA underwriting and earn-outs. SBA lenders treat the closing-date Purchase Price as the financed transaction value. Earn-out payments are post-close obligations of the buyer entity. They affect future cash flow but don't change the SBA loan size at closing.
  • Tax characterization. Earn-out payments are typically treated as additional purchase price (capital gain to seller, capitalized basis to buyer), but contingent and seller-services-related payments can be characterized as compensation. Get a tax opinion on this in diligence.