Creative ways of doing SBA compliant Earn Outs (without calling them so)

March 07, 2025

by a searcher from Harvard University - Harvard Business School in Austin, TX, USA

SBA 7a doesn't allow performance based payouts (earn outs) as part of the loan structure. Given many business that we see have huge volatility, I was wondering if any one have done earn outs without calling them that way and still have gotten their deal structure compatible with SBA 7a?
Maybe a side agreement? Happy to hear your thoughts.

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Reply by an intermediary
from The University of Chicago in Chicago, IL, USA

Interest on Forgivable Notes is very expensive to buyer. Interest can be zero.:
Each situation requires a different structure. Here is an example from an LOI approved by the 2 banks. Seller expected high growth:
The Forgivable Note of Two Million Dollars ($2,000,###-###-#### will be a 10-year note at no interest, payable annually based on EBITDA exceeding the target EBITDA amount of One Million Two Hundred Thousand Dollars ($1,200,000) with 20% of the excess, to be paid to Sellers within 90 days after the end of the previous year. EBITDA will be calculated consistent with Company’s prior practice. Further, any fees paid to Buyer or its portfolio companies, or its owners and management will be added back in calculating EBITDA. Seller will have access to Company’s monthly financials. Any unpaid amount of this Note at the end of 10-year will be forgiven.

Reply by a searcher
in Rawalpindi, Punjab, Pakistan

Structuring an SBA-compliant "earn-out" without explicitly calling it one requires creativity while ensuring full compliance with SBA 7(a) regulations. The key is to structure contingent compensation in a way that doesn't violate SBA rules prohibiting performance-based seller financing. Here are some alternative approaches: 1. Seller Note with Fixed Payments but Performance-Linked Forgiveness Structure a seller note with a fixed repayment schedule. Include a provision where the note is partially or fully forgiven if certain milestones (e.g., revenue retention, EBITDA thresholds) aren’t met. Since the payments are fixed and not performance-based, it can align with SBA guidelines while offering the buyer downside protection. 2. Escrow with Release Conditions At closing, a portion of the purchase price is placed in escrow. Release of funds can be tied to specific non-performance-based conditions (e.g., customer retention, legal claims, or inventory reconciliation). If the conditions aren’t met, the funds revert to the buyer. 3. Employment or Consulting Agreement for Seller Instead of a structured earn-out, the seller is retained as an employee or consultant with a performance-based bonus. Payments can be linked to the company’s success, as long as they’re structured as reasonable compensation rather than a contingent portion of the purchase price. 4. Royalty or Revenue-Sharing Agreement If the business has recurring revenue (e.g., SaaS, subscription model), consider a post-sale royalty based on revenue instead of an earn-out. The seller gets paid a fixed percentage of gross revenue for a set period without tying it to profit or performance targets. 5. Tiered Purchase Price Based on Pre-Closing Conditions Structure a two-part closing where part of the purchase price is determined based on trailing 12-month (T12) performance before closing. This way, the seller gets a payout based on performance before the SBA loan is funded, rather than an earn-out tied to post-closing performance. 6. Inventory or Working Capital Adjustments Instead of an earn-out, adjust the final purchase price based on actual working capital, inventory value, or AR collections at a future date. This aligns the seller’s incentives while keeping the structure SBA-compliant. 7. Second Lien Seller Financing with Contingent Forgiveness Seller carries a second-position note, subordinate to the SBA loan. The note has fixed terms, but if the business underperforms, the buyer has an option to negotiate forgiveness under pre-defined circumstances. These structures help bridge valuation gaps and align incentives without violating SBA rules. Have you seen any of these work in practice, or are you looking for something more specific to your deal?

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