Key Takeaways

• Earnouts help reconcile differing buyer and seller expectations by tying a portion of consideration to post-close performance, aligning incentives around client retention, advisor stability, and growth.
• Retention-based and growth-based earnouts serve distinct purposes, with retention earnouts typically paying in full when transitions are well-managed and growth earnouts carrying more uncertainty due to market and business-development variability.
• Clear metric definitions and thoughtful payoff structures are essential, including specifying data sources, exclusions, and payout gradients, to reduce ambiguity and minimize post-transaction disputes.

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Earnouts are a common feature in RIA transactions that, when properly structured, can bridge the gap between buyer and seller expectations on the outlook for client retention, advisor stability, pricing, and markets. A well-designed earnout turns differing expectations into contract terms: part of the price is paid at closing and the balance is paid if the business performs as expected. The tool works when the payout is tied to drivers the seller can influence and the definitions are clear.

The future of an RIA is influenced by variables with wide bands of potential outcomes: market performance, the durability of the fee schedule, retention and motivation of key people on both sides of the table, the stickiness of client relationships, and the effectiveness of the combined firm’s marketing engine. Without an acknowledgment of those unknowns, buyer and seller often anchor to different prices. Earnouts help reconcile those views by tying a portion of consideration to performance actually delivered post transaction, serving as both incentive for sellers and protection for buyers.

Retention and Growth: Different Roles, Different Risk

While earnout structures can take many forms, in practice most RIA earnouts fall into two broad categories: retention-based earnouts and growth-based earnouts. Retention earnouts compensate sellers for transitioning clients and keeping relationships intact through the transition, typically over 12 to 24 months. If the integration plan is sound and communication is handled well, both sides often expect these to pay in full.

Growth earnouts compensate and incentivize sellers for achieving certain growth thresholds post transaction. They usually run longer, often up to three years, and are tied to some measure of growth such as net asset inflows or recurring revenue growth rate. Because the outcome is less certain than pure retention, a dollar of growth-based earnout is generally worth less to the seller than a dollar of retention-based earnout when comparing offers.

Target Metrics

Metric selection is an important design consideration in earnouts. Typically, RIA earnouts will be tied to one of the following metrics:

• Net new assets (market-neutral). Defining net new assets as client flows (assets added less withdrawals) and excluding market movement keeps the focus on controllable activity—business development and relationship management—rather than market action.  This metric effectively shifts market risk to the buyer, giving the seller greater control over the metric.
• Recurring revenue. Revenue links directly to enterprise value and is straightforward to measure from billing files.  It also inherently includes market volatility unless the agreement includes explicit carve-outs.
• Normalized EBITDA. Buyers pay for cash flow, so EBITDA is intuitive as an earnout metric. In practice though, it is also the most susceptible to noise from items like corporate allocations, platform changes, the timing of hires, accounting treatments, and other factors that are often outside the seller’s control post-transaction. If EBITDA is to be used, it should be precisely defined and items where buyer or seller discretion could influence EBITDA should be anticipated and the treatment for such items agreed to in advance so as to minimize the likelihood of post transaction disputes.

Whatever the metric, it should be clearly defined in the transaction documents, with explicit data sources, inclusions / exclusions, timing conventions, and illustrative calculations. Disagreements over earnouts often trace back to ambiguity, not intent.

Payoff Structure

Earn-outs are generally structured in one of two ways: cliffs or gradients. Cliffs concentrate the entire payout on meeting a single threshold, while gradients scale the payout between defined performance levels. The difference seems subtle, but it often has meaningful implications once results begin to come in.

Cliff arrangements place significant value on what may ultimately be an immaterial difference, which can create friction if performance lands just above or below the stated trigger. Gradient structures, where payouts increase proportionally between a hurdle and a target (typically with a cap) tend to smooth those edges. They reduce sensitivity to rounding conventions or timing issues and often lead to more predictable administration.

Other structural questions typically receive similar attention: whether performance should be measured cumulatively or period-by-period, how to address unusual market movements if the metric isn’t fully market-neutral, how tuck-ins or cross-sell activity factor into the calculation, and how a later change of control affects the earn-out window. While the right answers vary by transaction, clarifying these points up front helps both sides understand how the arrangement is intended to function over its term.

Putting it Together

A workable earn-out does three things well. First, it measures a business the parties can actually observe post-close, with allocations and scope defined. Second, it selects a metric the selling team can influence and the finance team can compute without interpretation. Third, it pays along a curve over a reasonable term. When those elements are present, an earn-out is not a concession to disagreement so much as a way to align price with performance, allowing buyers to protect downside while giving sellers a path to the value they believe they can deliver.

About Mercer Capital

Mercer Capital’s investment management industry group provides valuation, transaction, litigation, and consulting services to a client base consisting of asset managers, wealth managers, independent trust companies, broker-dealers, PE firms and alternative managers, and related investment consultancies.