Definition
An earnout is a deal structure where you, the seller, receive a portion of the total sale price after the closing, contingent upon your practice achieving specific, pre-defined performance goals. This means part of your payment is at risk, tied directly to the practice’s future success under new ownership. Think of it as a performance-based bonus on top of the guaranteed amount you receive on day one.
Why This Matters to Healthcare Providers
Earnouts are common when a buyer and a seller disagree on the practice’s valuation. If you believe your practice has significant growth potential that isn’t reflected in past financial statements, an earnout allows you to “prove it” and get paid for that future value. However, the structure is full of legal pitfalls. Earnout metrics must be designed carefully to comply with regulations like the Anti-Kickback Statute and Stark Law, ensuring the payments are not disguised as rewards for patient referrals.
Example in Healthcare M&A
Scenario: An orthopedic group’s physician-owners are negotiating a sale to a larger health system. The physicians project a 25% increase in surgical cases over the next two years due to their strong reputation and new outpatient procedures. The health system’s valuation is based on the last three years of flat performance.
Application: To bridge this valuation gap, the deal includes an earnout. The physicians receive $10 million at closing. They can earn up to an additional $2 million if the practice hits specific targets for surgical volume and Adjusted EBITDA over the 24 months following the sale.
Outcome: If the physicians meet the targets, their total compensation reflects their optimistic forecast. If they fall short, they receive only a portion of the earnout, or none at all. Their final payment is directly linked to their ability to deliver on their growth projections under the new ownership structure.
Related Terms
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Frequently Asked Questions
What is an earnout in the context of healthcare practice sales?
An earnout is a deal structure where the seller receives a portion of the total sale price after closing, contingent upon the practice meeting specific pre-defined performance goals. It acts as a performance-based bonus in addition to the guaranteed payment received at closing.
Why do healthcare providers use earnouts in practice sales?
Earnouts are often used when the buyer and seller disagree on the practice’s valuation. They allow sellers to demonstrate significant growth potential not reflected in past financials and get compensated for that future value, while addressing valuation gaps between parties.
What legal considerations must be kept in mind when structuring an earnout in healthcare?
Earnout metrics must comply with regulations like the Anti-Kickback Statute and Stark Law to ensure that the payments are not disguised as rewards for patient referrals, thus avoiding legal pitfalls.
Can you give an example of how an earnout works in a healthcare M&A deal?
In an example, an orthopedic group negotiates a sale with a larger health system with a valuation gap due to projected growth. The deal includes a $10 million payment at closing plus up to $2 million earnout if specific surgical volume and Adjusted EBITDA targets are met over 24 months, aligning payment with realized growth.
What happens if the practice does not meet the earnout targets after the sale?
If the practice falls short of the earnout targets, the seller receives only a portion of the earnout payment or none at all, meaning the final payment is directly linked to the practice’s ability to achieve its growth projections under new ownership.