By Alex Lubyansky, Managing Partner. Published . Updated .
What should counsel review before you sign?
Review the purchase agreement, note and lender restrictions as one package. A payment promised in one document may be limited by another. Use this worksheet to identify open decisions before the terms are signed.
| Document | Decision to resolve | Review with counsel |
|---|---|---|
| Purchase agreement | What amount is payable at closing, deferred or conditional? | Reconcile the price, indemnification claims and any right to reduce later payments. |
| Promissory note | Who owes the money, when is it due and what changes on default? | Read principal, interest, maturity, balloon, prepayment, notice and cure terms together. |
| Security and guaranty documents | What supports repayment if the borrower cannot pay? | Identify collateral, existing claims, required perfection steps and any separate guarantor. |
| Subordination or standby agreement | When can payments or enforcement be blocked? | Compare permitted payments, notice, standstill, refinancing and senior-debt changes with the note. |
| Earnout schedule | What must happen before a contingent amount is earned? | Define the metric, accounting rules, operating commitments, records access and objection process. |
| Closing and follow-up checklist | Which documents, approvals and actions remain open? | Assign responsibility for signatures, consents, searches, releases, filings and post-closing reporting. |
For a buyer, focus on workable payment obligations and the agreed recovery process for seller claims. For a seller, focus on collection risk, information rights and restrictions on payment or enforcement. A note is different from a performance-based earnout.
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The download organizes questions and responsibilities. It is not a promissory note or a contract template. Start an assessment with a non-confidential summary; arrange document sharing after intake.
Request Engagement AssessmentFor the broader transaction, see seller-side M&A representation. For a financing explanation before reviewing documents, read the business-sale seller financing guide. Alex Lubyansky leads every engagement, reviews every document, and leads negotiation and closing, with an associate supporting the work.
When part of a business-sale price is deferred, identify whether it is a note with a repayment obligation or an earnout contingent on agreed performance. The distinction affects which documents, payment conditions and post-closing rights need review. An attorney who structures earnouts and seller notes in purchase agreements, and who advises clients when those provisions are disputed post-close, brings a different skill set than one who handles closing documents alone.
This guide covers what earnouts and seller notes are, how they are structured in small-business M&A, the SBA-specific constraints on seller notes, how earnout disputes arise and what drives them, and what to do if you are in a post-close dispute about either structure. Related guides: earnout agreements explained, earnout dispute resolution, earnout vs. seller note comparison, and the SBA acquisition attorney overview.
1 How Earnouts Work in Small-Business Acquisitions
An earnout bridges the gap between what a seller believes the business is worth and what a buyer is willing to pay today. The seller receives the base purchase price at closing. If the business performs according to agreed metrics after the close, the seller receives additional payments. If it does not, the seller receives nothing additional. The structure allocates the risk of future performance between the two parties.
Why Earnouts Are Used
Earnouts appear most often when: the seller's stated revenue or profit figures are based on recent trends that the buyer cannot fully verify; the seller claims the business has significant growth potential that is not yet reflected in historical financials; the buyer and seller are too far apart on valuation for the deal to close on an all-cash basis; or the buyer wants the seller to remain engaged in the business after close and the earnout creates that incentive. Each of these rationales creates a different earnout structure with different metric choices and different risks.
Common Earnout Metrics in Small Business Deals
Revenue-Based Earnouts
- -Easier to measure than profitability metrics
- -Risk: seller cannot control buyer's pricing decisions post-close
- -Must specify which revenue lines are included
- -Need clarity on when revenue is recognized for earnout purposes
EBITDA-Based Earnouts
- -Reflects profitability, but buyer controls expense decisions
- -Risk: buyer adds overhead that reduces EBITDA
- -Must define EBITDA: which add-backs are permitted
- -Management fees and intercompany charges need explicit treatment
The Earnout Period
Earnout periods in small-business deals typically run one to three years after closing. Longer periods favor buyers (more time to miss) and shorter periods favor sellers (less time for things to go wrong). The purchase agreement should specify: the start date of the earnout period, whether it resets if the business is sold again during the period, how performance is measured if the earnout period spans a fiscal year end, and what happens to the earnout if either party fails to fulfill their post-close obligations.
Earnout Limitations Under SBA Rules
Financing-program requirements can restrict contingent purchase-price arrangements. Identify every performance-based payment in the proposal and ask the lender to confirm eligibility under the rules applicable to the transaction. Do not rely on the amount being small or the payment being called a note.
SBA and Earnouts: Practical Reality
Do not assume an earnout is permitted in an SBA-financed acquisition, or that relabeling a contingent payment as a note resolves eligibility. Obtain lender confirmation against the applicable program requirements before relying on either structure. A fixed debt obligation and a performance-contingent payment serve different purposes.
2 Seller Note Terms: What Belongs in the Promissory Note
A seller note is a legally binding debt instrument. It is not a handshake agreement about deferred payments. The note must specify the terms precisely enough to be enforceable. In SBA deals, it must also comply with the lender's subordination requirements.
Principal Amount and Interest Rate
The note must state the principal amount, the interest rate (fixed or variable with a specified index), and how interest accrues during any standby period. For SBA deals on full standby, interest typically accrues but is not paid until standby is released. The accrued interest balance must be tracked and included in the payoff amount when the standby period ends.
Payment Schedule and Standby Terms
For SBA deals, the payment schedule must reflect the standby period. No payments are due during the standby period. After standby is released, the payment schedule begins. The note should specify what triggers standby release (typically SBA lender's written consent), what the payment schedule looks like after release, and whether the note has a balloon payment or fully amortizes. These provisions must be coordinated with the SBA lender's subordination agreement.
Acceleration and Default Provisions
Acceleration clauses allow the seller to demand full payment of the note balance upon specified default events. Common triggers: the buyer misses a payment after the standby period; the business is sold again; the buyer entity is dissolved; or the buyer files for bankruptcy. Each trigger must be defined with clarity, and any cure period (time to fix the default before acceleration) must be specified. In SBA deals, acceleration rights are limited by the lender's subordination requirements and cannot interfere with the SBA lender's priority.
Prepayment Rights
The note should specify whether the buyer can prepay the note without penalty, whether prepayment requires lender consent during the standby period, and how prepayment is applied (to principal, to accrued interest, or a combination). Sellers who want to limit prepayment may negotiate prepayment premiums, though these are less common in small-business deals. SBA lenders may have requirements about prepayment of subordinated debt that need to be reflected in the note terms.
Governing Law and Enforcement
The note must specify the governing law, which court has jurisdiction for disputes, and whether the parties have agreed to arbitration or mediation before litigation. For buyers and sellers in different states, the governing law choice matters for enforcement. The note should also address whether attorney's fees are recoverable by the prevailing party in an enforcement action.
3 Earnout Disputes: How They Arise and What to Do
Most earnout disputes are not caused by bad faith. They are caused by purchase agreements that did not define the earnout metric precisely enough, did not address the buyer's right to change business operations post-close, or did not include a clear dispute resolution process. By the time the dispute surfaces, the parties are already at odds, and the purchase agreement's provisions determine what options they have.
Dispute Type 1: Metric Definition Disputes
The most common earnout dispute. The seller calculates the earnout metric one way; the buyer calculates it differently. Both are applying a definition that the purchase agreement did not make clear enough. Common ambiguities: whether a particular revenue item is included in the defined revenue line; whether a specific expense is an add-back to EBITDA; and how deferred revenue at the beginning and end of the earnout period is treated. Prevention requires metric definitions that anticipate these questions. Resolution requires analyzing the purchase agreement language and, if necessary, the parties' negotiation history.
Dispute Type 2: Post-Close Business Control
After closing, the buyer controls the business. They can change pricing, raise costs, reallocate overhead, change accounting methods, and pivot strategy. Any of these decisions can reduce the earnout metric. Sellers often claim these changes were designed to reduce the earnout. Buyers argue they were legitimate business decisions. The purchase agreement must include covenants about how the buyer will operate the business during the earnout period: what they must do, what they are prohibited from doing without seller consent, and what standards apply. Without these covenants, the seller has limited recourse even if the buyer made decisions that effectively eliminated the earnout.
Dispute Type 3: Reporting and Audit Rights
If the purchase agreement does not give the seller the right to review the buyer's financial records supporting the earnout calculation, the seller cannot verify the accuracy of the buyer's reports. Sellers should negotiate audit rights: the right to review the earnout calculation, to have an independent accountant verify the calculation, and to dispute the calculation within a defined time window. Without audit rights, the seller is taking the buyer's word for the outcome.
What to Do If You Are in an Earnout Dispute
The first step is to review the purchase agreement's earnout provisions and dispute resolution clause. Most purchase agreements designate accounting arbitration (by an independent CPA or accounting firm) for metric calculation disputes, and litigation or arbitration for broader breach of covenant claims. The dispute resolution mechanism determines how quickly and economically the dispute can be resolved. Attempting to litigate an accounting calculation dispute in state court is expensive and slow. Accounting arbitration is typically faster but only addresses the calculation, not the underlying conduct claims.
Earnout Dispute Resolution Checklist
- ✓Locate the earnout provisions and dispute resolution clause in the purchase agreement
- ✓Identify the specific metric definition and whether the calculation is disputed
- ✓Review post-close covenants to determine whether buyer conduct violated them
- ✓Check whether the audit rights clause applies and invoke it if available
- ✓Identify applicable deadlines for raising a dispute (many agreements have short windows)
- ✓Determine whether accounting arbitration or litigation applies to the specific claim
Seller notes in SBA deals: confirm the actual restrictions
Have the lender confirm whether the seller note is part of the required equity structure or additional acquisition debt. That distinction matters to underwriting and the proposed repayment terms. A seller note is not required for every acquisition.
Separate payment restrictions from enforcement restrictions
Ask which principal and interest payments are permitted, whether interest accrues during a blocked period, and what must happen before payments can resume. Then review lien priority and any restriction on acceleration, suit or collateral enforcement. Permission to receive a scheduled payment is different from permission to enforce after default.
Resolve conflicts before the closing documents are signed
Compare the lender-approved financing terms with the purchase agreement, note and standby or subordination agreement. Record any unanswered question about payment dates, default notices, refinancing or lender consent. The buyer, seller and lender need a consistent set of documents; do not leave an assumed exception for the closing table.
The SBA's Standby Creditor's Agreement guidance identifies restrictions on lien rights and action against the borrower or collateral. Review the actual lender-approved agreement alongside the note; a repayment schedule alone does not establish a right to collect.
5 What the Purchase Agreement Must Include for Earnouts and Seller Notes
The purchase agreement is where both structures are defined. Drafting errors here produce disputes that take years and considerable legal fees to resolve. These are the provisions that require the most care.
Earnout Provisions Checklist
- 1 Metric definition: Revenue, EBITDA, gross profit, or operational milestone, defined with the same precision as a financial statement definition. Include: what is counted, what is excluded, how recognition timing works, and how adjustments for extraordinary items are handled.
- 2 Earnout period and measurement dates: Start date, end date, measurement intervals (annual, quarterly), and what happens if the earnout period overlaps a fiscal year change.
- 3 Buyer operating covenants: What the buyer must do and must not do during the earnout period. Typically includes: maintain adequate staffing, preserve key customer relationships, not change accounting methods without seller consent, not allocate unreasonable overhead charges, and not make decisions specifically intended to reduce the earnout metric.
- 4 Reporting obligations: When the buyer must deliver earnout reports, what format those reports must take, and what level of supporting detail is required.
- 5 Seller audit rights: The seller's right to review the buyer's books and records supporting the earnout calculation, the time window to exercise that right, and the mechanism for retaining an independent accountant.
- 6 Dispute resolution: Accounting arbitration for metric calculation disputes; litigation or arbitration for breach of covenant claims. Time limits for raising disputes. Who bears the cost of the independent accountant.
Seller Note Provisions Checklist
- 1 Amount, rate, and term: Principal, interest rate, and total term. For SBA deals, confirm these with the lender before drafting.
- 2 Standby period and payment schedule: When standby begins, when it ends, what triggers release, and the post-standby amortization schedule.
- 3 Acceleration triggers: Specifically defined events that accelerate the note, including cure periods and lender consent requirements before acceleration.
- 4 Subordination: Express subordination to the SBA lender. Reference to the three-party subordination agreement.
- 5 Security: Whether the seller note is secured by business assets or is unsecured. SBA lenders will object to seller note security interests that compete with their own collateral position.
For the purchase agreement that contains these provisions, see asset purchase agreement review. For the LOI stage where these terms are first committed, see LOI review attorney. For the SBA-specific overlay on all of these structures, see small business acquisition attorney.
Frequently Asked Questions
What is an earnout in a business acquisition?
An earnout is a contingent payment structure in which part of the purchase price is paid to the seller after closing, based on the business's future performance against agreed metrics. Common metrics include revenue, EBITDA, gross profit, or specific operational milestones. The buyer pays the base price at closing and makes earnout payments only if the business meets the defined targets during the earnout period. Earnouts appear most often when the buyer and seller disagree on current business value or when the seller's representations about future performance need to be backed by deferred consideration.
What are the most common earnout disputes?
The most common earnout disputes arise from three sources. First, metric definition disputes: the purchase agreement's definition of the earnout metric is ambiguous, and the parties calculate different results using the same financial data. Second, buyer control disputes: after closing, the buyer changes the business's accounting methods, cost allocations, pricing, or strategy in ways that reduce the earnout metric, and the seller claims the buyer intentionally depressed the measurement. Third, reporting disputes: the buyer provides earnout reports that the seller believes are inaccurate, but the purchase agreement does not give the seller audit rights or a dispute resolution process. All three types of disputes are largely preventable with precise purchase agreement drafting.
What is a seller note in a business acquisition?
A seller note (also called seller financing or a purchase money promissory note) is a debt instrument through which the seller effectively loans part of the purchase price to the buyer. The buyer pays the seller in installments over a defined period rather than the full purchase price at closing. Seller notes are common in small business acquisitions when the buyer's equity and third-party financing do not cover the full purchase price. In an SBA-financed transaction, have the lender confirm how this particular note is treated and which payments and remedies are permitted. Do not assume that every seller note has the same standby terms.
What is SBA full standby for seller notes?
Full standby restricts principal and interest payments for the agreed period. Confirm the applicable program requirements and the lender-approved terms for the specific transaction. Review payment blocks, lien subordination and enforcement restrictions separately; they are not interchangeable. Raise these issues while negotiating the financing structure.
How should earnout metrics be defined in a purchase agreement?
Earnout metrics should be defined with the same level of specificity as financial statement definitions. For a revenue earnout, the purchase agreement should define what counts as revenue: which product lines, which customer accounts, which geographic regions, and whether intercompany transfers or related-party transactions are included. For an EBITDA earnout, the agreement must define which expenses are deducted, how one-time costs are treated, and whether the buyer's post-close overhead allocations are included or excluded. The more precisely the metric is defined, the fewer grounds there are for post-close dispute.
Can a buyer legally reduce earnout payments by changing how the business operates?
This is the central question in most earnout disputes. The buyer owns the business after closing and has the right to operate it as they see fit. However, purchase agreements frequently include covenants requiring the buyer to operate the business in the ordinary course during the earnout period, to maintain sufficient resources to give the earnout a fair opportunity to be achieved, and to refrain from changes that are specifically intended to reduce earnout payments. Whether a given buyer decision violates these covenants depends entirely on the specific language in the purchase agreement and the facts of the post-close conduct. Sellers who believe a buyer has manipulated the earnout measurement need to review the purchase agreement's covenants and dispute resolution provisions before asserting a claim.
What acceleration provisions can be included in a seller note?
Acceleration provisions allow the full outstanding balance of the seller note to become immediately due and payable upon specified triggering events. Common acceleration triggers in seller notes include: sale of the business before the note is paid; default on a payment obligation; material breach of the purchase agreement by the buyer; dissolution or bankruptcy of the buying entity; and failure to maintain required insurance or business licenses. SBA lenders typically require that acceleration provisions in subordinated seller notes be consistent with the terms of the senior loan and not interfere with the lender's priority position. The seller note's acceleration language must be coordinated with the SBA lender's subordination agreement.
Does Acquisition Stars handle earnout dispute resolution?
Yes. Acquisition Stars advises buyers and sellers on earnout disputes that arise after a transaction closes. Dispute resolution may involve: reviewing the purchase agreement's earnout provisions and covenants, analyzing the financial records underlying the earnout calculation, assessing whether the dispute resolution mechanism in the agreement (accounting arbitration, litigation, mediation) applies, and advising on whether the buyer's post-close conduct gives rise to a claim. Acquisition Stars also structures earnout provisions in purchase agreements to minimize dispute risk before the deal closes. The firm handles matters nationwide.
Structuring an Earnout or Seller Note?
Whether you are negotiating earnout terms before the deal closes or working through a dispute after closing, the starting point is reviewing the purchase agreement's provisions. Request an engagement assessment to discuss your situation.
Questions About Earnout or Seller Note Terms?
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