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

By Reetika Gupta and Varun Mahajan

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 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 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.

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.