How much to ask for as an earnout?

February 09, 2021
by a searcher from Monash University in Melbourne VIC, Australia
I'm a self-funded searcher currently looking at business that supplies equipment to warehouse and distribution centers and am considering an offer. I'm interested in hearing opinions on how much I should ask for as an earn out?
Asking Price - $3m ($2m for business and $1m for stock)
EBITDA - around $800k after adjustments
The business has been operating for over 20 years and the owners (2 guys in their early 70s) would like to retire. It was advertised for sale in 2015, 2016, and 2018 but the owners say they didn't receive any serious offers.
At this stage I haven't come across any major issues that would discourage me from making an offer. Sales can be a little lumpy due to the nature of the business, however it has remained profitable for 5+ years.
How much would be a reasonable amount to ask for as an earnout? 30%? 50%? I want my offer to be taken seriously but I can also see there is potential here for quite a generous earnout.
from INSEAD in Singapore
You should put in an earn out proportion large enough to ensure they are incentivised to help the business and you flourish, but also realistic enough for them to not categorise you as a 'not serious offer'. Also should take into account their health and willingness to continue working/contributing. They are after all in their 70s.
20-30% valuation earn-out would be reasonable. If they want a lower percentage you could ask for a longer period e.g. 5 years instead of 3 years. If they are confident in the business and motivated to help you, they will take it. If they are not willing to take it then the question is whether there is something you don't know.
5 years performance at existing EBITDA would be close to break even if take into account interest/taxes. And if the business performance fail to meet requirements, then you are only 2M out of pocket instead of 3M, again of which 1M is inventory - even if it gets discounted if liquidated (I assume stock means inventory)
from The University of Chicago in Chicago, IL, USA