Selling a business: earnouts, seller financing, and the after-tax math

Owners spend years thinking about what their business is worth and about forty-five minutes thinking about deal structure — which is backwards, because structure routinely moves the owner's after-tax, risk-adjusted proceeds by more than the last 20% of price negotiation ever could. Two offers with identical headlines can differ by hundreds of thousands of dollars once you account for asset-versus-stock treatment, how much of the price is contingent on an earnout you may not control, the credit risk in a seller note, and how each dollar is characterized for tax. The discipline that protects you is simple to state: never compare offers by price. Compare them by expected after-tax proceeds, with every contingent dollar discounted for the odds it never arrives.

Asset sale vs. stock sale: the first fork

Buyers of small businesses overwhelmingly prefer asset sales: they cherry-pick assets, leave historical liabilities behind, and get a stepped-up basis they can depreciate. Sellers generally prefer stock (or membership-interest) sales: one clean capital gain on the whole thing. The tax gap is widest for C-corps, where an asset sale is taxed twice — once inside the corporation on the gain, again when proceeds are distributed — a structure that can consume 45–50% of the price and makes stock treatment (or years of advance planning) close to mandatory. For pass-throughs the asset-sale penalty is smaller but real: the price gets allocated across asset classes (the purchase price allocation negotiated in the agreement), and portions land as ordinary income — depreciation recapture on equipment, inventory, and any consulting or non-compete payments — rather than capital gain. The allocation schedule is a negotiation inside the negotiation, and every dollar you move from ordinary-income classes toward goodwill is taxed at capital-gains rates instead of your top bracket.

Earnouts: buying the buyer's optimism with your risk

An earnout bridges a valuation gap: part of the price pays only if the business hits targets after closing. Used honestly, it's how a seller gets paid for growth the buyer won't underwrite. Used carelessly, it's a discount dressed as a bonus — because after closing, the buyer controls the levers the targets depend on. Earnout design is therefore mostly about control and measurement: base targets on revenue or gross profit rather than EBITDA (net-income metrics are trivially manageable by a buyer who adds overhead allocations); define the accounting and who audits it; cap the buyer's ability to starve the business of resources or redirect customers; secure acceleration if they sell or shut down the unit; and keep the earnout period short — one to three years. Then discount it: seasoned advisors treat earnout dollars as worth perhaps 50–60% of face value in expectation. If a deal only beats the alternative because of undiscounted earnout money, it doesn't beat the alternative.

Seller financing: you are now the bank

In small-business sales, seller notes are common — often 10–30% of the price, paid over three to seven years with interest. The note does real work: it bridges buyer financing gaps, signals your confidence, and (via installment-sale treatment) spreads the capital gain across the years payments arrive, which can hold you under higher-bracket and net-investment-income-tax thresholds. Remember your position — usually subordinate to the buyer's bank — and price the scenario where the buyer runs your life's work into the ground and the note pays nothing. Depreciation recapture also can't be deferred into installments; it's taxed in the year of sale even if most of the cash arrives later, a liquidity trap worth modeling before you accept a small down payment.

• Personal guarantee from the buyer — the entity that bought your business is only as good as the person behind it.
• Security interest in the business assets you just sold, perfected with a UCC filing, so default puts you in line for collateral.
• Financial covenants and reporting: quarterly statements, limits on new debt and owner distributions while your note is outstanding.
• A market interest rate for the risk — a below-market rate is a price cut wearing a bow, and the IRS imputes minimum rates anyway.
• Acceleration on resale: if the buyer flips or refinances the business, your note gets paid first, not assumed by a stranger.

Compare offers on one page

1. 1
   Split every offer into certainty buckets

   Cash at close; escrowed/held-back amounts; seller note; earnout. Same buckets for every offer, no netting across them.

2. 2
   Apply risk discounts

   Cash 100%; escrow 90–95%; secured seller note 80–90% depending on buyer quality; earnouts 40–70% depending on metric, control terms, and period.

3. 3
   Model the tax on each bucket

   Character (capital vs. ordinary), timing (year of sale vs. installments), and state tax — including whether you'll change states before payments finish.

4. 4
   Subtract transaction costs

   Broker/banker success fees (often 4–10% at small-business scale), legal and accounting, and any debt payoff — off the top before comparing.

5. 5
   Read the risk story, then the number

   Two offers within 5% of each other after modeling are decided by buyer quality, employee treatment, and closing certainty — not by the spread.

The bottom line

A business sale is a portfolio of payments with different tax characters and different probabilities, sold under a single headline number that none of them individually equals. Fight for stock treatment or a favorable allocation; design earnouts around metrics you can verify and terms the buyer can't quietly sabotage; underwrite any seller note like the subordinated lender you're becoming; and reduce every offer to expected after-tax proceeds before comparing anything. The buyers you'll face do this modeling as a profession. The sellers who do it too — with a deal attorney and a CPA engaged before the LOI, not after — routinely keep six figures that the headline never mentioned were in play.