Seller Financing and Earnouts in Technology Company Acquisitions
In a technology company sale, the seller believes the clients, contracts and team will carry over to the new owner. The buyer worries that a large client could leave, contracts could fail to renew or a key engineer could resign once the seller steps away. Technology company seller financing and earnouts are two ways buyers and sellers sometimes share that uncertainty by deferring part of the purchase price. Neither is right for every transaction, and both need careful drafting.
This article is general information for buyers and sellers of existing, operating technology companies. Deal terms should be negotiated with qualified attorneys, accountants and tax advisors, and nothing here is legal, tax or financial advice.
What Seller Financing Is
With seller financing, the seller accepts part of the price as a promissory note that the buyer repays over time. A seller note can reduce the cash the buyer needs at closing and signal the seller’s confidence in the business. When a bank or SBA-backed loan is involved, the seller note is typically subordinate to the senior lender, and the lender may set conditions on its payments.
What an Earnout Is
An earnout makes part of the price contingent on future results. In a technology company, an earnout might be tied to renewal of specific client agreements, recurring revenue from existing clients or gross profit over a defined period. Earnouts can bridge a gap between what a seller believes the business is worth and what a buyer is willing to pay upfront.
Why These Structures Can Fit Technology Companies
- Contract risk: client agreements may allow termination or require consent on a sale
- Relationship risk: clients may be loyal to the seller personally
- People risk: engineers and developers may leave after a sale
- Revenue variability: project and resale revenue can change from period to period
See our articles on managed services contracts and technical staff retention.
Lender and Program Limits
Some lenders and loan programs limit earnouts or impose rules on how seller notes are structured, when they may be paid and whether the seller can remain involved. Buyers using SBA-backed financing should confirm what is allowed early in the process. See our guide to SBA loans for technology companies.
Drafting Issues to Address
- How renewals, recurring revenue or gross profit will be measured, and from which records
- Whether resold products and pass-through costs count toward the metric
- How changes the buyer makes to pricing, tools, staff or services affect the calculation
- What happens if a client leaves for reasons outside either party’s control
- Payment timing, interest, default terms and subordination
- The seller’s role and responsibilities during the earnout period
- How disputes over the calculation are resolved
Considerations for Sellers
A seller note carries the risk that the buyer cannot pay, and an earnout carries the risk that results fall short. Sellers should evaluate the buyer’s experience and financing, consider what security they will hold and understand how subordination affects their position. See our guide on how to sell a technology company.
Considerations for Buyers
Deferred payments still need to be paid from the company’s cash flow alongside senior debt and operating costs. Buyers should model those payments carefully. Our guide to technology company valuation explains how risk affects price.
US Professional Funding helps buyers finance the acquisition of existing, operating technology companies, including transactions that combine senior financing with seller notes. Learn more about our technology acquisition financing.
