Seller Financing Pros & Cons: Seller Note vs. Earnout

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August 10, 2021

by a searcher from University College London, University of London in London, UK

To me, Seller Note is debt with no tie to performance, Earnout is deferred performance-based payment.

How does Seller Note reduce risk of buying a bad company? Is Earnout always better (if available)?

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commentor profile
Reply by a searcher
from University of Pennsylvania in Miami, FL, USA
How does Seller Note reduce risk of buying a bad company? Because the seller knows more than anyone about the quality of the company you're buying. If they're willing to become a major lender to the company by extending a large seller note, it's a good sign of the seller's confidence in the business. If they're unwilling to extend credit, it's a sign that the business might be a bad business.

An earnout is similar, but more risky to the seller. They may be confident in the quality of the business but not want to get paid based on how you run the business post-close - this is why I have spoken to a number of sellers who are willing to do a large seller note but unwilling to do an earnout.
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Reply by a searcher
in Toronto, ON, Canada
Earnouts are better, but the seller's advisors usually tell them not to participate in one. One of my colleagues recommends having the seller's note paid in full on your exit for the new value.

Ex: if the seller's note is 10% of a $1m business, have the seller hold it as an earnout/seller's note until you exit the company. Then his seller's note is worth 10% of your exit value in 5-7 years. It's one way to pay less up front and pay more to the seller (if you can grow the business and sell it for more than you bought it for).
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