Overview of an Earn Out
Let's discuss what an earn-out is. An earn-out is a financial incentive the buyer provides you after a transaction.
In this case, a transaction can be a partial or complete sale of your hospital, so let's use the example your practice generates a million dollars in revenue and produces a profit of about twenty percent or two hundred thousand dollars of cash flow.
This is defined as cash flow or EBITDA.
Now the buyers are buying the cash flow from your business so the buyer says I'm gonna buy your practice which produces two hundred thousand dollars of net profit or a cash flow, and I'm gonna buy it at a multiple of six times with the sixth time multiple taking two hundred thousand dollars times six equals the value of a practice of 1.2 million dollars.
Now, an earn-out is the incentive buyer says in one year's time. I'm going to give you an incentive and by the growth of cash flow in the practice so that's you're down the road your practice is producing 240 thousand dollars of cash flow.
This represents an increase of forty thousand dollars the buyer has agreed on up front to give you six times multiple for that growth so that total value that you get one year down
The road is going to be two hundred and forty thousand dollars.
The total value of the practice in the initial transaction phase was 1.2 million dollars and then a year later because you've grown the cash flow the value gets 240,000 so the total value of the practice ends up being 1 million four hundred and forty thousand dollars and that's how you benefit from an earn-out from a buyer.p.1