HeritagePlatform Group
Insights · The deal itself

Earnouts, holdbacks and seller notes — explained by someone who structures them

By Reetika Gupta and Varun Mahajan

◆ What this piece is: a plain mechanical explanation of the three instruments buyers use to bridge a price gap, written by a buyer who proposes them. What it is not: legal or tax advice — the drafting of every one of these terms belongs with your attorney and CPA. Education, not advice.
If you read nothing else

Earnouts, holdbacks, and seller notes all bridge a price gap by moving risk onto you — in different amounts, with different controls. The honest ranking: holdback (bounded and dated), seller note (you become the buyer’s lender), earnout (you bet on numbers someone else will run). Which is fair for you is a question your attorney and CPA weigh with you.

Here is the uncomfortable thing, said first: the number at the top of an offer is not the price. It is the sum of every dollar that could arrive under the best possible outcome. The price is what actually clears your account after the ifs and the whens have done their work — and the structure underneath the headline decides how large that gap is. Two offers with the same top line can be very different deals. You cannot tell them apart by reading the top line harder. You tell them apart by taking the structure apart.

There are really only three instruments a buyer uses to move money out of “cash at close” and into “later, maybe”: the seller note, the holdback, and the earnout. We structure these for a living, from the buyer’s chair. That is exactly why this is worth your ten minutes — the person who builds an instrument is the person who knows where it bends against you.

The seller note: you become the buyer’s lender

A seller note is the simplest of the three and the most underestimated. The buyer does not pay the whole price in cash; you carry a loan for part of it, and the buyer repays you over years, with interest, out of the business’s cash flow. That is a normal and often fair part of how businesses change hands. But be precise about what you are doing: you are extending credit to your own buyer. So read a note the way a bank would read one. What is the interest rate, and does it reflect the risk you are taking? What is the term — how many years does your money sit inside a company you no longer control? What security stands behind it — a lien on the business assets, a personal guarantee, or nothing but goodwill? And where does it sit in the repayment line: if a bank is also lending into the deal, your note is almost certainly subordinated, which means the bank gets paid first in any bad year, and you get what is left. None of those four words is decoration. Each one should be negotiated, and your attorney should draft them, not the buyer’s.

The reality gap
Today
A gap has appeared between your number and theirs, and structure is being offered as the bridge.
The gap
Every instrument moves risk to your side of the table; the questions are how much, and who controls it.
What’s possible
You can name where the risk sits in any structure before you sign it.
The first move
For each instrument offered, write one sentence: what has to go right, and who controls whether it does.

The holdback: insurance against named risks — bounded and dated

A holdback (usually held in escrow, a neutral account) is different in kind. Part of the agreed price does not come to you at close; it waits until a set date passes or a specific condition is confirmed. Its honest purpose is insurance for the buyer against the promises you made — that the numbers were accurate, that there are no hidden liabilities, that a specific known risk (a tax question, a pending claim) resolves the way you both expect. Here is the part sellers miss: a well-drafted holdback is about the past, not the future. If what you attested to holds up, the money releases to you — even if the business has a soft year under its new owner. That makes the two tests of a fair holdback simple: it must be bounded (tied to named risks, not “anything we find”) and dated (it releases on a calendar, not at the buyer’s discretion). A holdback without a date is not insurance. It is an option the buyer holds on your money.

The earnout — and the one question that decides it

An earnout is a payment contingent on how the business performs after closing — a revenue level, a profit level, a customer target, measured in a window that runs after the sale. It sounds like a bonus. So ask the only question that matters: who controls the levers that hit the target? Pricing. Hiring. Investment timing. Which costs get allocated where. How a sale gets booked. Every one of those levers moves the number your payment depends on — and every one of them is held by the person who controls the business after close. Which is not you.

THE EARNOUT QUESTION: WHO HOLDS THE LEVERS? The levers that move the target Pricing — raise it, cut it, discount it Hiring — staff up, or run lean this year Investment timing — spend now, profit later Cost allocation — whose overhead lands here Revenue recognition — when a sale counts Customer mix — which work gets chased None of these has to be used against you for the target to be missed. Ordinary, defensible decisions are enough. Who holds them after close The buyer. All of them. The person who controls the business after closing controls every input to the number your payment rides on. Who carries the risk You. All of it. You are exposed to operating outcomes in a company you no longer operate — with no levers left in your hands. The test, in one sentence: an earnout measured on anything the buyer can influence is not a bonus. It is a discount wearing a bonus’s clothes.
FIGURE 1Who controls the levers. The earnout’s structural problem is not bad faith — it is that ordinary, defensible decisions by the new owner are enough to move the number your payment depends on, and you hold none of the levers.Heritage editorial framing, from the buyer’s chair. Mechanism, not a claim about any transaction.

The honest ranking

Put the three side by side and rank them the way a careful seller should: cash, then note, then holdback, then earnout. Cash at close is certain. A note is a real obligation with interest and (if you negotiated well) security — but it carries credit risk for years. A holdback is near-certain if it is bounded and dated, because it turns on the past you already know. An earnout is the only one of the four that depends on future performance under someone else’s hands — which is why it belongs at the bottom, and why a headline built mostly out of earnout is a smaller number than it looks.

◆ ILLUSTRATIVE ONLY — INVENTED FIGURES One headline, taken apart: $5,000,000 Ranked from most certain (top) to least certain (bottom) Cash at close — $3,500,000 CERTAIN In your account on the closing day. Done, yours, final. The only part of the headline that needs no further reading. Seller note — $750,000 over five years, with interest CREDIT RISK A loan you carry. Real money if the business keeps paying — and your exposure if it stumbles. Price it, secure it, and check where you stand in the repayment line. Holdback — $250,000 in escrow, releasing at eighteen months CONDITIONAL Near-certain if you represented the business honestly — it turns on the past you attested to, not on how the company performs next. Bounded and dated, or it isn’t fair. Earnout — $500,000 if profit targets are hit after close A MAYBE Depends on future performance under the buyer’s hands. Discount it heavily in your own mind — then anything that arrives is a gift, not a rescue. The honest ranking: cash > note > holdback > earnout. ◆ heritageplatformgroup.com · Reetika Gupta and Varun Mahajan
FIGURE 2The same headline, four kinds of money. Every figure above is invented for illustration — the split, the amounts, the dates. What is real is the ordering: each layer down carries more risk to you, and a headline is only as good as its bottom layers are honest.Illustrative only — invented figures. Heritage editorial; not an offer, a valuation, or advice.

Where each instrument is legitimately fair

None of this means the instruments are tricks. Each has a fair use. A seller note is fair when it is priced like the loan it is — market interest, real security, a term you can live with — and when it bridges a genuine financing gap rather than substituting for money the buyer simply prefers not to pay. A holdback is fair when it covers a named, specific risk, in a bounded amount, with a release date on the calendar. And an earnout is fair in one narrow situation: when you and the buyer honestly disagree about the near future, and the terms give you a real chance of collecting. That means a metric as close to revenue as possible (the hardest number to move with allocations), a window that overlaps the transition period you are still part of, written covenants to run the business in the ordinary course, your right to see the numbers, and a named neutral way to settle a dispute. An earnout you can audit is a term. An earnout you cannot audit is a hope.

EARNOUT TERMS: FAIR VS UNFAIR A fair earnout A discount in disguise METRICMETRIC WINDOWWINDOW COVENANTSCOVENANTS VISIBILITYVISIBILITY DISPUTESDISPUTES Revenue-near, defined in writing down to the accounting treatment. “EBITDA,” undefined — whoever controls the books defines it later. Overlaps the transition you are still part of, with influence in the room. Years after you are gone, hostage to decisions you never saw made. Written promise to run the business in the ordinary course, no starving it. No covenants. The buyer may steer around the target entirely lawfully. Your contractual right to see the numbers behind the calculation. The buyer’s books are final and you see only the result. A named neutral arbiter, agreed before signing, at shared cost. “The parties will negotiate in good faith” — which means: you sue, or fold. Every line in the left column is drafted by attorneys. Do not accept a term sheet summary of any of it.
FIGURE 3The five places an earnout is won or lost. Each row is decided before signing, in drafting, by your attorney — never after closing, in goodwill.Heritage editorial. Structural comparison only; the drafting itself is your attorney’s work, not ours.
The honest con — read this before you weigh anything above

Heritage is a buyer, and we structure these instruments from the buyer’s chair — on the deals we pursue, we are the ones proposing the note, the holdback, the earnout. Structure works in a buyer’s favor: it shifts risk toward you and lets a headline look larger than the certain money inside it. That is our interest, named. Two things are also true. Because we buy to hold, what we put in a structure we intend to honor across years of ownership, not engineer down before an exit — and our record is exactly what it is: our principals and partners have acquired and operate three businesses, and beyond them there is nothing we can point you to yet. If what you want is maximum cash at close with nothing carried, say so early — to us and to every buyer — and read every headline, including ours, by its bottom layers.

Which arm this becomes

Structures are Heritage Capital’s daily work. Reviewing one you have been offered is Heritage Advisory’s — for a fee that does not depend on any close, which is the point.

The con, stated by us: We use these instruments too. When we propose one, this piece is the standard to hold us to — especially the one question that decides an earnout.

Heritage Advisory, Studio, and Intelligence are paid services; this section tells you which one this subject becomes, and what is wrong with it. Heritage Capital is a principal buyer, never a broker; sellers pay us no fee. All four arms, with each one’s cons.  ·  Heritage Capital · Heritage Advisory

The first move, before any structure is on the table

The instruments above exist to bridge a gap between what a buyer believes and what a seller believes. The smaller that gap, the less structure you will ever be asked to carry — and the gap closes with evidence. The Read is a structured look at how your business actually runs and how owner-dependent it truly is, done before anyone is negotiating anything. Owners who arrive at a table with that evidence in hand get asked to carry less of the risk.

Education, not advice. Every instrument on this page is drafted by your attorney and weighed with your CPA — and any figure you ever see from us comes with its derivation attached.