An earnout is a payment structure that allows part of a dental practice’s purchase price to be paid after closing if the practice meets agreed-upon performance goals. Earnouts can help buyers and sellers reach an agreement when they have different expectations about a practice’s value, but they should be structured carefully to reduce the risk of disputes after the sale. For dentists buying or selling a practice in Los Angeles, understanding how earnouts work can help determine whether they are an appropriate part of the transaction.
What Is an Earnout in a Dental Practice Sale?
In a traditional practice sale, the buyer pays an agreed purchase price at closing. An earnout works differently. Instead of paying the entire purchase price upfront, a portion of the purchase price is deferred and becomes payable only if certain conditions are met after closing.
Earnouts are often used when the buyer and seller have different views about the future performance of the practice. For example, a seller may believe patient retention and future production justify a higher valuation, while the buyer may prefer to pay that additional amount only if the practice performs as expected.
Rather than preventing the transaction from moving forward, an earnout can provide a way to bridge that valuation gap.
Why Do Buyers and Sellers Use Earnouts?
Earnouts are designed to balance risk between the parties.
From the seller’s perspective, an earnout provides an opportunity to receive additional compensation if the practice continues to perform well after the sale. This may be especially appealing when the seller believes the practice has strong growth potential that is not fully reflected in the buyer’s initial offer.
Buyers often view earnouts differently. Rather than paying for projected future performance upfront, they can tie part of the purchase price to measurable results achieved after taking ownership.
Earnouts may also be useful when:
- The practice has experienced recent growth that is difficult to evaluate
- The seller intends to remain involved during a transition period
- Future patient retention is uncertain
- Market conditions make valuation more difficult
When structured appropriately, an earnout allows both parties to move forward while sharing some of the uncertainty surrounding future performance.
How Are Earnouts Usually Structured?
No two earnouts are identical. The structure depends on the parties’ goals and the characteristics of the practice being sold.
Common earnout metrics may include:
- Collections during a specified period after closing
- Production levels achieved by the practice
- Patient retention benchmarks
- Revenue generated from particular service lines
- Performance over a defined period, such as 12 or 24 months
Whatever metric is selected, it should be objective and clearly measurable. The purchase agreement should define exactly how performance will be calculated, when payments become due, and what documentation will be used to determine whether the earnout has been achieved. The more precisely these terms are drafted, the less room there is for disagreement after closing.
What Can Go Wrong With an Earnout?
Earnouts often appear straightforward when negotiated, but disagreements can arise once the buyer begins operating the practice.
For example, what happens if the buyer changes scheduling procedures, modifies staffing, or introduces new service offerings that affect production? What if patient volume declines because the seller retains sooner than expected? Questions like these can create disagreements if the agreement does not clearly address how performance will be measured.
Another common source of conflict involves accounting methods. If the agreement simply references “collections” or “profit” without explaining how those figures will be calculated, the parties may later interpret the numbers differently.
To reduce the likelihood of disputes, an earnout agreement should clearly define:
- The performance metrics being measured
- The time period covered by the earnout
- How financial calculations will be performed
- Whether the seller will continue working after closing
- The circumstances under which earnout payments may change
Addressing these issues before the transaction closes is generally far easier than attempting to resolve disagreements afterward.
Should Every Dental Practice Sale Include an Earnout?
Not necessarily. Many practice sales are completed successfully without one.
An earnout may be appropriate when the parties have different opinions regarding value or when future performance is difficult to predict. In other situations, a fixed purchase price may provide greater certainty for both buyer and seller.
The decision often depends on factors such as the stability of the practice, the seller’s continued involvement, financing considerations, and the willingness of both parties to share future risk. Rather than assuming an earnout is always beneficial or always problematic, buyers and sellers should evaluate whether it supports the goals of the specific transaction.
Structure Earnouts Before They Become Disputes
An earnout can be an effective tool for completing a dental practice sale when it is drafted with clear expectations and objective performance standards. Careful planning helps buyers and sellers understand how payments will be calculated and reduces uncertainty after closing. If you are buying or selling a dental practice in Los Angeles and are considering an earnout, contact Polished Legal to discuss how the arrangement may fit into your transaction.
Frequently Asked Questions
How long do earnouts usually last?
Many earnouts last between one and two years after closing, although the appropriate timeframe depends on the structure of the transaction and the agreed performance metrics.
Are earnouts common in dental practice sales?
They are less common than fixed-price transactions but may be used when buyers and sellers disagree about valuation or future performance.
Can the seller continue working during the earnout period?
Yes. In some transactions, the seller remains with the practice for a transition period, and the earnout may take that continued involvement into account.
What happens if the practice does not meet the earnout targets?
The answer depends on the purchase agreement. Some earnouts reduce or eliminate additional payments if the agreed performance benchmarks are not achieved.
