Types of Earnouts for FBA Businesses
May 6, 2021
Many sellers shut down at the idea of an earnout. If they were selling their business, why would they not walk away with all the cash up front?
Sellers with this mentality often miss huge opportunities. Now more than ever in Amazon FBA deals, earnouts are a way to bring in big buyers to acquire your business and make even more money than list price. Earnouts bridge the gap between buyers’ and sellers’ goals and help close the deal that works in both interests.
Earnouts look different at every level of FBA deals. We break down what to expect in every pricing tier and how sellers and buyers can leverage data and trends to prepare for their best possible earnout.
Let’s uncover why earnouts should be a part of your exit plan and how to make them work for you.
What is an earnout?
In simple terms, an earnout is where a buyer puts a down payment on a business, and once he or she owns the business, pays off the remainder of what he or she owes over a set period of weeks, months, or in some cases, even years.
Earnouts are common in our industry because traditional financing is harder to come by. It’s a way of creating a form of seller financing when traditional routes like bank loans aren’t available. An earnout provides buyers with a way to finance digital acquisitions and gives sellers more opportunities to draw buyers to their businesses.
An earnout becomes likelier as sales prices increase. This trend is reflected in our data. Earnouts in the high six-figure-and-up range allow buyers to mitigate their risk and give sellers the chance to close the sale of their business much more quickly.
While most sellers would opt for as much cash up front as possible, an earnout can sometimes allow the seller to make more money from the business over the lifetime of the earnout. This might happen when sellers charge interest on the earnout or set performance milestones for the earnout that would allow them to earn more if the business manages to grow beyond expectations.
Earnouts typically have milestones that mark when certain amounts of money are paid by the buyer to the seller. Milestones could be as simple as monthly or quarterly payments made to the seller or set at certain growth levels at which the seller would be paid a corresponding amount. Ultimately, milestones help pace the earnout and keep both sides accountable for each step of the business transfership.
What our data showed about earnouts
Earnouts will not likely go anywhere anytime soon. However, our data show that their use is always changing.
According to the 2021 State of the Industry Report: “In 2020, 35 FBA businesses were sold using an earnout. That is just a 5% decrease from 2019 and a 21% increase from 2018. This two-year increase makes sense, as the businesses in this category were much larger than any we sold in 2018. Since traditional financing is difficult to obtain in our industry, seller financing through an earnout is often the best form of leverage for buyers looking to make a deal.”
Across the 35 deals that used an earnout, the average amount paid up front was 69.76%.
To really understand what was happening with our marketplace and FBA earnouts, consult the data below. Later, we will refer to this data and discuss how pricing tiers can affect earnouts.
This is an interesting time to examine earnouts in the FBA space as we enter what we have called the “season of the seller.” The market, particularly for FBA businesses, very much favors sellers. Thanks to institutional capital and increased interest from private equity and high-net-worth individuals to acquire top-in-class Amazon FBA businesses, these assets are selling for record prices, with substantial cash offered up front.
This shift ultimately affects earnouts and how they come into play in deal structures. More cash-heavy buyers mean more cash up front, but savvy institutional buyers know how to use an earnout to win deals and protect their investment. The right earnout that promises an upside for sellers can help buyers beat the competition and allow sellers to earn more from their businesses than ever before.
Earnouts tend to look different at different pricing tiers. So, you know what to expect at every price range. Let’s break down what earnouts typically look like and what kinds of advice buyers and sellers can take away at every level.
Sub-$100k Pricing Tier
Marketplace data
Only four of the 33 deals we did last year in this pricing tier had earnouts. The average amount of cash up front was 56.38%.
Common earnout structures
Businesses selling under $100K sell most often for all cash upfront offers. These deals tend to move quickly because buyers have the most liquidity at this price. To stay competitive, buyers close on deals quickly by offering all cash up front.
Earnouts are rarer in this range and are likely used in special case scenarios, such as a business in decline.
What sellers should know
Sellers should expect decent buyer interest for strong businesses in this price range. A deal can move very quickly after it goes live in our marketplace, so sellers should be ready to commit their time and attention to negotiating with buyers for the weeks following the business’s launch.
Sellers, it’s okay to be wary of any buyer who offers you a long earnout or minimal cash upfront in this range, as it might not be the best deal for you. If there is ample buyer interest once your business enters the marketplace, there is no reason to settle on a quick offer that doesn’t maximize your cash up front or at least help you meet your goals.
This can be a competitive pricing tier for buyers, so sellers can expect to get all cash up front with no earnout if they have built a solidly performing business.
What buyers should know
If you are not prepared to buy in this pricing tier with most of the listing price up front, you may have difficulty winning the deal. There is more capital available for buying in this range, so outmaneuvering other buyers without cash would be tough.
If you really would like to stick to an earnout, you may need to shop for assets that are distressed, riskier, or require more hands-on optimization. Since competition will be smaller for these assets, you can have wiggle room to create an earnout that fits your needs.
Remember, buyers, putting cash down on a business isn’t bad! You benefit from getting the groundwork and profitability laid, which isn’t easy to do in FBA. You buy back valuable time, and that can be worth all cash up front.
$100k−$250k Pricing Tier
Marketplace data
Eight of the 33 deals we did last year in this pricing tier had earnouts. The average amount of cash up front was 74.81%.
Common earnout structures
Our data show that earnouts climb slightly in this range. But because there is still more capital available to buyers in this range on the lower end, deals are still quite competitive.
Earnouts will be the simplest and shortest in this range. An earnout wouldn’t typically extend beyond 12 months. Here’s an example of a typical structure in this range:
- 60–80% cash up front
- Deferred payment increases in complexity from:
- Guaranteed monthly installments from 3–12 months (rarely longer)
- Revenue or profit share until the sales price is met
- Tiered payments (example: If sales are 80%, you get $5,000; 90%, $7,500; 100%, $10,000) and a sliding scale (same as above but the exact percentage).
What sellers should know
While this range still sees a decent amount of cash up front, sellers should anticipate the need for a buyer to deploy an earnout at this level.
According to our former 2020 Industry Report, “In the $100–250k range, buyers might see an asset that is almost ready to scale up. Scaling up comes with all sorts of associated risks and, more importantly, all sorts of capital needs.
Buyers in this range might be likelier to ask for an earnout knowing that they will need to deploy additional capital to inventory to achieve the economies of scale that will skyrocket the business revenue.”
A buyer may need wiggle room to achieve a proper ROI on their investment in your business. If your business is doing well and is on the precipice of strong growth, you can work with them by negotiating some kind of profit share or performance earnout to take advantage of upsides in the business.
What buyers should know:
Remember, buyers, there is still pretty healthy competition in this range, so you’ll still need most of the cash upfront in most cases.
Understandably, you’ll still need cash on hand to scale the business, so if you plan to negotiate an earnout, you may want to deploy the tiered payments mentioned above to mitigate risk and pace your payments based on growth outcomes.
$250k−$500k Pricing Tier
Marketplace data
Of the 11 deals we closed in this pricing tier, four had earnouts. The average amount of cash up front was 74.74%.
Common earnout structures
These deals are very similar to the level above, but they become more complex, with more risk mitigation for the buyer and upside for the seller.
These deals may include multiple versions of the above options and can also include the following:
- Stability Payments (if the next 12 months’ sales are more than the last 12 months) of 10–20% of the sales price.
- Performance Payments: A percentage of revenue or profit more than the TTM (trailing 12 months multiple)
- Some of these deals can end up with a payout above the listing price, if the performance goes great.
What sellers should know
Our data show that there is still a decent amount of cash upfront deals. Even when an earnout was deployed, about 75% of the sales price was paid at closing to the seller.
Even at this mid-range, deals start getting sweeter for sellers. We have started seeing deals with earnouts that offer the above list price should the business perform well.
Sellers should note their business’s growth trajectory. If it has grown rapidly prior to sale and seems like it will continue, this is a good time to negotiate a piece of that future growth through performance payments.
What buyers should know
There is still a sweet spot for buyers in this range because mid-range FBA deals tend to be out of reach for first-time buyers and too small for institutional investors. So while it is important to craft a deal structure that remains competitive, you might have more wiggle room in this range to get creative in negotiations simply because competition is less fierce.
You could use this to your advantage to remain focused on risk mitigation by using stability payments and utilizing performance payments to sweeten the deal for the seller and ensure that you’re creating drip payments secured by strong financial performance.
$500k–$1m Pricing Tier
Marketplace data
All eight deals in this pricing tier had earnouts. The average amount of cash up front was 74.26%.
Common earnout structures
Building on the deal structures above, earnouts in this range tend to have very similar structures. Deals can go above listing price more often, more attention is paid to the holdback and bonus payments, and the conversation becomes more about the growth of the business and both parties participating in said growth. At this range, deals start to become mini versions of a typical fund deal (which we will explore more in the next pricing tier).
What sellers should know
Buyers are looking for an asset that they can grow. While sellers may want to walk away with cash and be done with the business, they could be missing an opportunity to earn even more than what they could earn from the initial sales price.
Sellers should also be aware that every deal we closed last year in this pricing tier had earnouts, so being able to make a clean exit from the business with all cash up front isn’t as likely here. It would be wise for sellers in this range to anticipate an earnout and figure out how to negotiate an earnout structure that benefits them. If they can put themselves in the shoes of a buyer and remember the buyer’s growth goals in negotiations, leveling with the buyer and taking an earnout to participate in the upside of future growth may lock in a lucrative exit for the seller.
What buyers should know
Consider looking at the seller as a potential partner in the deal process and the future development of the business. Since buyers in this range are looking to take a business to the next level and are likely aiming for a multimillion valuation down the road, the deal structure of the sale can be an important first step to help get there. In what ways could the seller help you, as a buyer, achieve your goals? Could they stay on to help scale the business in return for equity? Could you negotiate a performance payment that would incentivize the seller to accept less cash up front?
Remember, to get the seller on board with this kind of structure, you’ll need a performance record to prove your future growth plans. But if you have the capital and experience to take the business to the next level, there is no reason that you and the seller couldn’t both be a part of the business’s next chapter.
$1m+ Pricing Tier
Marketplace data
Above the $1 million mark, 11 of the 12 businesses we sold in this tier had earnouts. The average upfront paid in this tier was 65.88%.
Common earnout structures
The most common buyers of these businesses will be PE groups and funds who have raised capital for FBA acquisitions. While the cash upfront average was 65.88%, we are seeing the amount of cash upfront rise as deals in this range become intensely competitive.
Typically, earnouts in these deals will often revolve around the future performance of the business and are paid on a yearly basis. In this pricing tier, we begin to see earnouts extend beyond 12 months to a few years.
Stability payments have become more common in these deals. This comes into play after the upfront cash has been paid, and at the 12-month mark, a payment is made based on anticipated growth milestones. It’s usually somewhere around 5−10% of the total deal value and a bonus to the seller based on business growth.
Performance-based payments also come into play at this range, and this is where sellers can walk away with a good deal more than the list price for a growing business that is bought by a capable FBA buyer with capital behind them. The most popular setup for these payments would be EBITDA profit growth and then some share of that for the seller. So if a business grows 100% the next year after purchase, the seller can sometimes get as high as 50% of that amount based on the trailing 12-month performance.
Seller-retained equity can also be more common in this range, as some sellers want to stay involved with the business as a fund buyer deploys capital to take it to the next level.
Notably, in this range, it is most common to see a letter of intent (LOI) for deals and exclusive due diligence periods of about 30 days to give buyers time to do their own thorough investigation of the business before purchasing and secure a business ahead of other buyers.
What sellers should know
We had previously mentioned this in the Season of the Seller, but it’s worth repeating: “For large performance-based earnouts, the seller needs to trust the buyer’s ability to run an Amazon business that hits this performance metric for the payout to be released. This is a vital reason for sellers to come to our marketplace, as it gives them a chance to meet with multiple buyers and determine which buyer they are most comfortable moving forward with.”
Increasingly, sellers can be choosy about who they sell to. It’s a wise move, as there will be many capable buyers at the negotiation table, but when there is a performance payment on offer, sellers will want to ensure the buyer can really deliver on their promises. Sellers should look for a fund that has a track record and team to grow the newly acquired business. They should also consider the buyer a future partner, so matching the ethos and ideology of the buyer would be beneficial, as sellers will be somewhat connected to the buyer for years to come.
What buyers should know
Buyers in this range need to come ready to deploy a strong deal structure and an earnout that mitigates risk but is still enticing to the seller. Since competition will be intense for top-performing FBA businesses, buyers will need to be ready to move quickly and be flexible on their deal offers to keep up with other buyers.
While performance payments can incentivize sellers, buyers can still protect themselves in the process. If things go poorly, this structure improves the returns for the buyers on a decreasing asset, which they expect to grow for them. So there are ways to stay safe in the earnout, but that will come with the balance of still trying to win over the seller to accept the deal.
Managing earnouts the right way
The scariest part of an earnout for sellers is wondering if they will actually receive the scheduled payments for their business.
The way to ensure the safety of your earnout is to make sure it is legally protected. If you were to go about a private deal on your own, you would need the correct legal documentation in place and use escrow to store and transfer payments between both parties. It’s a lot to take on, and even with legal measures in place doesn’t guarantee everything will go right.
That’s why having a third party manage and protect your earnout can be pivotal to the success of your deal. We are the only broker in the industry who handles migrations and manages earnouts for our sellers. We protect sellers by taking on the responsibility of managing the earnout by collecting the payments from the buyer and paying out the seller on the agreed-upon schedule. We also will hold on to certain aspects of the business, such as the domain, until the earnout is fully paid, giving us some leverage in making sure the buyer pays the remaining amount.
Along the way, we’ve learned a thing or two about how to manage earnouts right. Here are a few things we’ve found that help earnouts go smoothly:
- Earnouts are typically structured on an agreed-upon schedule. We have found that the payments that arrive on time most often tend to be monthly scheduled payments, as opposed to the longer-term yearly balloon or performance-based ones. This makes sense because performance-based earnouts may take some time to calculate and therefore process, while the monthly payments are running on an expected amount.
- The more leverage we have, the better. For websites, holding the domain is usually fine. But in the case of an FBA business where the domain might not be that critical, we may hold on to the trademark until the final payment is submitted to protect the FBA seller.
- The earnouts where we have the buyers cash/credit on file (COF) with us for us to send payments are always the best and easiest to manage.
- Buyers who opt to receive automated invoices from us have typically been the best earnout payers.
To streamline earnouts, it makes the most sense to automate the process as much as possible. That means opting to receive automated invoices or having the cash on hand with us to let us process the payments. The more you lean on us as a service provider in the earnout phase, the easier and better the process becomes for all parties involved.
Walking away with the most for your hard work
The best way to ensure that your earnout goes smoothly and to get the most from your deal structure is to not go through it alone.
Leverage your resources—use a broker to protect and manage your earnout, and have them work with you to negotiate a fair and lucrative deal. An exit and an earnout will likely mark the biggest windfall of your life, so it’s worth the effort of making sure it goes right.
If you’re interested in selling your business, you can start the process here. If you’re a buyer, look at our marketplace to see high-quality businesses available for acquisition.
