How To Survive An Earnout

"As many as half of all small business acquisitions involve earnouts, which generally last from two to four years and range from 15% to 30% of the purchase price (though 50% is not unheard of). Earnouts are particularly common in acquisitions of high-growth companies and those with unproven products. Takeovers of service businesses, in which the entrepreneur's relationships with clients are crucial, are also likely candidates for earnouts...

The key to a successful earnout lies in negotiating smart, achievable targets, making sure they're spelled out clearly in your contract, and keeping some power over decisions that directly affect them. You'll also want to nail down your own position in the new company -- and your eventual exit from it.

PROTECT YOURSELF
Before you agree to anything, get a lawyer who specializes in mergers and acquisitions. Besides helping to negotiate the deal, a lawyer can keep emotions from boiling over when things get dicey. "If you feel uncomfortable taking a hard line with a buyer, who may also be your future employer, your attorney can be the bad guy," says Mark Mihanovic, a partner with Los Angeles law firm McDermott Will & Emery. "You can stand back and be above the fray."

The next step is obvious: Get the largest up-front payment you can, even if the earnout is substantial....Then, you've got to negotiate the targets for the earnout -- usually revenue or profit goals -- and make sure you've got a reasonable chance of achieving them. But what was reasonable under your leadership may not be under the new owners. So it's essential to protect yourself in case they decide to operate differently..."

Read more in this excellent Businessweek.com article.