A $15 million sale with a $3 million earn-out: a sample earn-out walkthrough

The best way to understand an earn-out is to watch one play out on paper. Headline numbers tell owners one story. The two-year math tells another. Below is a composite example that stitches together patterns we see repeatedly in lower-middle-market deals. The company, the figures, and the outcome are illustrative, not a real client case.

Setting the scene

Imagine a precision-machining business in the Midwest doing roughly $18 million in revenue and $3 million in Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA). The founder, call her the owner, is 61 and ready to step back. A strategic buyer signs a Letter of Intent (LOI) with a $15 million headline enterprise value. The structure in the LOI reads:

• $12 million cash at close
• $3 million earn-out tranche, paid in two annual installments, tied to Trailing Twelve Months (TTM) EBITDA
• Target: $3 million TTM EBITDA at the end of each measurement year
• Payout mechanics: linear scaling between a 70% hurdle and a 100% cap, with each year's tranche capped at $1.5 million

Translation in plain language. If the business hits $3 million of EBITDA in a given year, the owner receives the full $1.5 million for that year. If EBITDA comes in below $2.1 million (the 70% hurdle), that year's tranche pays zero. Between $2.1 million and $3 million, the payout scales linearly.

The formula the owner should keep on a sticky note:

Payout_year = $1,500,000 x (Actual_EBITDA - $2,100,000) / ($3,000,000 - $2,100,000)

Capped at $1.5 million and floored at zero.

Year 1: 90% of target

Year 1 is strong but not a home run. The post-close team retains customers, lands one new contract, and absorbs a software integration that pulls EBITDA down slightly. TTM EBITDA at the end of month 12 lands at $2.7 million, which is 90% of the $3 million target.

Plugging into the formula:

Payout_year_1 = $1,500,000 x ($2,700,000 - $2,100,000) / ($3,000,000 - $2,100,000)
Payout_year_1 = $1,500,000 x ($600,000 / $900,000)
Payout_year_1 = $1,500,000 x 0.6667
Payout_year_1 = $1,000,000

So on 90% of the EBITDA target, the owner receives roughly 67% of the Year 1 tranche. That is the first lesson of linear scaling with a hurdle. A hurdle shifts the payout curve to the right. Hitting 90% of EBITDA does not mean receiving 90% of the dollars. It means receiving the share of the band between the hurdle and the cap that you actually traversed.

Year 2: 65% of target

Year 2 is harder. A key customer concentration issue the buyer flagged in diligence actually materializes. One account cuts order volume by 40%. The replacement sales pipeline takes longer than planned. EBITDA for the TTM period at month 24 lands at $1.95 million, which is 65% of target.

Because $1.95 million is below the $2.1 million hurdle, the formula outputs a negative number, which is floored at zero.

Payout_year_2 = $1,500,000 x ($1,950,000 - $2,100,000) / ($3,000,000 - $2,100,000)
Payout_year_2 = $1,500,000 x (-$150,000 / $900,000)
Payout_year_2 = -$250,000, floored at $0
Payout_year_2 = $0

The hurdle wiped out the entire Year 2 tranche. Not scaled down. Zero. This is the mechanic owners most often miss when they read "linear with hurdle" in an LOI. A soft year does not mean a soft payout. It can mean no payout.

Total actual payout versus headline

Running the two years together:

• $12,000,000 cash at close
• $1,000,000 Year 1 earn-out
• $0 Year 2 earn-out
• Total actual proceeds: $13,000,000

Against a $15 million headline, the owner realized $13 million, or roughly 87% of the sticker price. The $3 million earn-out tranche paid out at 33%. The SRS Acquiom 2025 Mergers and Acquisitions (M&A) Deal Terms Study, based on more than 2,200 private-target acquisitions valued at $505 billion closed between 2019 and 2024, found that earn-outs pay roughly 21 cents on the dollar across the dataset, and roughly 41 percent of earn-outs pay zero. A partial outcome like this one is closer to the norm than the exception.

Three lessons the owner should take

One. Model the hurdle, not just the target. The target gets the attention in LOI conversations. The hurdle does the damage. In this example, the difference between a hurdle at 70% and a hurdle at 50% would have been $450,000 of Year 2 payout at the exact same business performance. Negotiating hurdle placement is often higher-value than negotiating the headline target.

Two. Owner dependence can be one of the most expensive earn-out risks. The Year 2 miss traces back to a customer concentration problem that was known at diligence. The owner was the primary relationship holder on that account. After close, with the owner stepping back, the relationship frayed. This is the exact failure mode that pre-sale readiness work targets. Reducing owner dependence in the 12 to 24 months before a sale (documenting relationships, cross-training, formalizing processes, broadening the sales motion) does not just increase enterprise value at close. It materially raises the probability the earn-out actually pays out. Buyers write earn-outs because they are nervous. A business that runs without the owner gives them less to be nervous about, which translates into tighter earn-outs, lower hurdles, or no earn-out at all.

Three. Treat the earn-out as conditional, not as cash at closing. When an owner compares a $15 million offer with a $3 million earn-out against a $13.5 million all-cash offer, the honest comparison is not $15 million versus $13.5 million. Model your expected payout under your own assumptions, then compare the risk-adjusted totals. In this example the realized total was $13 million against a $13.5 million all-cash alternative. The all-cash offer is often the better deal. Running the math on expected payout, not headline, is one of the most clarifying exercises before signing.

A note on these numbers

The figures above are a composite constructed to illustrate hurdle and cap mechanics. They are not drawn from any client engagement. Every actual earn-out has its own definitions of EBITDA, its own measurement cadence, its own protective covenants (or lack thereof), and its own interaction with working-capital pegs, holdbacks, and representations and warranties coverage. Owners reading this piece should treat it as a mental model, not a forecast.