What’s a Fair Earn-Out Structure in a Software M&A Deal?
In software M&A, earn-outs are often the bridge between a seller’s valuation expectations and a buyer’s risk tolerance. But while they can align incentives and unlock value, they can also become a source of post-closing tension if not structured thoughtfully. So, what does a “fair” earn-out look like in a software transaction?
This article explores the key principles of fair earn-out design, common pitfalls, and how experienced advisors like iMerge help both sides navigate this nuanced component of deal structuring.
Why Earn-Outs Are Common in Software M&A
Software companies—especially SaaS businesses—often trade at high revenue or EBITDA multiples based on future growth potential. Buyers, particularly private equity firms or strategic acquirers, may be hesitant to pay full value upfront if:
The company is early-stage or has limited operating history
Key customer contracts are short-term or not yet secured
There’s significant founder dependency or key-person risk
Revenue growth is accelerating but not yet proven sustainable
In these cases, an earn-out allows the seller to “earn” a portion of the purchase price based on post-closing performance—typically over 12 to 36 months. This structure can help close valuation gaps while giving the buyer downside protection.
Core Elements of a Fair Earn-Out
While every deal is unique, a fair earn-out structure typically includes the following characteristics:
1. Clear, Measurable Metrics
The most common earn-out metrics in software deals include:
Revenue (e.g., ARR, MRR, or total bookings)
EBITDA or Adjusted EBITDA
Customer retention or churn
Milestone-based metrics (e.g., launching a new product or entering a new market)
Fairness starts with clarity. Metrics should be objectively measurable, auditable, and tied to the seller’s influence post-close. For example, if the seller is staying on as CEO, EBITDA-based earn-outs may be appropriate. If the seller is exiting, revenue-based metrics are often more suitable.
2. Reasonable Time Horizon
Most earn-outs in software M&A range from 12 to 36 months. Longer periods increase uncertainty and reduce the seller’s control over outcomes. A fair structure balances the buyer’s need for performance validation with the seller’s desire for timely compensation.
3. Defined Payout Mechanics
Earn-out payments should be:
Clearly scheduled (e.g., annually or quarterly)
Based on tiered thresholds (e.g., 100% payout at $10M ARR, 50% at $8M)
Not subject to buyer discretion—avoid vague language like “at buyer’s sole determination”
Some deals include a “catch-up” provision, allowing sellers to earn missed payments in later periods if cumulative targets are met. This can be a fair compromise when growth is lumpy or seasonal.
4. Protections Against Manipulation
One of the most contentious issues in earn-outs is post-close control. Sellers often worry that buyers will cut costs, reallocate resources, or change strategy in ways that depress performance. To mitigate this, fair earn-outs often include:
Operating covenants requiring the buyer to run the business in the ordinary course
Restrictions on reallocating key personnel or budgets
Consider a SaaS company with $5M ARR, growing 40% YoY. The seller believes the business is worth $25M based on forward ARR multiples. The buyer, however, is only comfortable paying $20M upfront due to customer concentration and limited contract terms.
A fair earn-out might look like this:
Upfront payment: $20M at closing
Earn-out period: 24 months
Metric: ARR at end of Year 2
Payout tiers:
$1M if ARR ≥ $6.5M
$2.5M if ARR ≥ $7.5M
$5M if ARR ≥ $9M
Catch-up clause: If Year 1 misses target but Year 2 exceeds, seller can still earn full amount
This structure rewards the seller for continued growth, gives the buyer downside protection, and aligns incentives during the transition period.
Common Pitfalls to Avoid
Even well-intentioned earn-outs can go awry. Here are a few red flags to watch for:
Overly complex formulas that are hard to track or audit
Unrealistic targets that require hypergrowth to achieve
Ambiguous definitions of key terms like “Adjusted EBITDA” or “Net Revenue”
No dispute resolution process in case of disagreement
At iMerge, we’ve advised on dozens of software and SaaS transactions where earn-outs played a pivotal role. Our approach includes:
Valuation modeling to test different earn-out scenarios
Negotiation support to align buyer and seller expectations
Legal coordination to ensure terms are clearly documented
Post-close advisory to monitor performance and mitigate disputes
We believe earn-outs should be a tool for value creation—not a source of friction. With the right structure, they can unlock upside for both parties while preserving trust and alignment.
Conclusion
A fair earn-out structure in a software M&A deal is one that balances risk, rewards performance, and minimizes ambiguity. It should be grounded in measurable metrics, realistic targets, and mutual trust. Whether you’re a founder preparing for exit or a buyer managing downside risk, thoughtful earn-out design is essential to a successful transaction.
Founders navigating valuation or deal structuring decisions can benefit from iMerge’s experience in software and tech exits — reach out for guidance tailored to your situation.
What Should I Include in a Confidential Information Memorandum (CIM)?
In the world of mergers and acquisitions, the Confidential Information Memorandum (CIM) is more than just a document — it’s your company’s first impression to serious buyers. For software and technology founders considering a sale, the CIM is a strategic asset that can shape buyer perception, drive valuation, and accelerate deal momentum.
But what exactly should a CIM include? And how do you strike the right balance between transparency and positioning?
This article outlines the essential components of a CIM, with a focus on software and tech-enabled businesses. Whether you’re preparing for a full exit or exploring growth capital, understanding how to craft a compelling CIM is critical to a successful outcome.
What Is a Confidential Information Memorandum?
A CIM is a detailed, confidential document prepared by a company (or its M&A advisor) to present the business to potential acquirers or investors. It typically follows the signing of a non-disclosure agreement (NDA) and serves as the primary marketing document in a sell-side process.
Think of it as a prospectus for your business — one that tells your story, outlines your financials, and highlights your strategic value. For buyers, it’s the foundation for initial valuation modeling and due diligence planning.
Key Sections to Include in a CIM
While the structure may vary slightly depending on the industry and deal size, a well-prepared CIM for a software or technology company should include the following components:
1. Executive Summary
High-level overview of the business
Key investment highlights
Summary of financial performance and growth trajectory
Transaction rationale (e.g., full sale, recapitalization, growth equity)
This section should be concise but compelling — it sets the tone for the rest of the document. A strong executive summary can determine whether a buyer reads on or moves on.
2. Company Overview
Founding story and evolution
Mission, vision, and core values
Legal structure and ownership
Organizational chart and key team bios
Buyers want to understand not just what the company does, but why it exists and who’s behind it. For founder-led businesses, this section often carries emotional weight — and strategic importance.
3. Products and Technology
Overview of core products or services
Technology stack and architecture
Product roadmap and innovation pipeline
Intellectual property (IP) and proprietary assets
For SaaS and software companies, this section is critical. Buyers will assess scalability, defensibility, and technical debt. Be prepared to address how your platform is built, maintained, and differentiated.
4. Market Opportunity
Industry landscape and trends
Target customer segments
Competitive positioning and market share
Growth drivers and barriers to entry
Use data to support your claims. Reference third-party research (e.g., Gartner, IDC, PitchBook) and include TAM/SAM/SOM analysis where appropriate. This section helps buyers understand the upside potential.
5. Go-to-Market Strategy
Sales channels and distribution model
Customer acquisition cost (CAC) and lifetime value (LTV)
Marketing strategy and conversion funnels
Customer success and retention programs
As we’ve discussed in Conversion Rate Optimization (CRO), understanding how your business acquires and retains customers is essential to valuation. Buyers will scrutinize your unit economics and scalability.
Include clean, GAAP-compliant financials with clear footnotes. If you’re using adjusted EBITDA, be transparent about add-backs. For guidance, see our article on Website Valuation and Discretionary Earnings.
7. Customer and Revenue Metrics
Top customers and concentration risk
Churn rate, net revenue retention (NRR), and MRR/ARR
Contract terms and renewal rates
Customer testimonials or case studies (if permitted)
For SaaS companies, metrics like NRR and logo retention are often more telling than GAAP revenue. Buyers will also want to understand contract structures — especially in recurring revenue models.
8. Management and Team
Key executives and their roles
Succession planning and retention risks
Incentive structures and equity ownership
Buyers often view the team as part of the asset. If the founder plans to exit post-transaction, it’s important to outline transition plans and identify leadership continuity.
9. Legal and Regulatory Considerations
Corporate structure and cap table
Pending litigation or disputes
Compliance with data privacy laws (e.g., GDPR, CCPA)
IP ownership and licensing agreements
This section should preempt red flags. As we noted in Completing Due Diligence Before the LOI, early transparency can build trust and reduce surprises later in the process.
10. Transaction Details and Process
Type of transaction sought (e.g., full sale, minority investment)
Instructions for submitting indications of interest (IOIs)
While valuation guidance is often omitted from the CIM, some sellers choose to include a range or reference prior funding rounds. This section should also outline how the process will be managed — especially if an advisor like iMerge is leading the transaction.
Best Practices for Crafting a CIM
Tailor the narrative: Position your business in a way that aligns with buyer priorities — whether that’s growth, profitability, or strategic fit.
Balance detail with clarity: Avoid overwhelming readers with data. Use visuals, charts, and summaries to enhance readability.
Maintain confidentiality: Redact sensitive customer names or trade secrets unless the buyer is deep in the process.
Work with experienced advisors: Firms like iMerge help craft CIMs that resonate with both strategic and financial buyers, drawing on deep sector knowledge and transaction experience.
Conclusion
A well-structured CIM is more than a formality — it’s a strategic tool that can shape buyer perception, accelerate diligence, and ultimately influence valuation. For software and technology founders, investing the time and expertise to get it right is essential.
Founders navigating valuation or deal structuring decisions can benefit from iMerge’s experience in software and tech exits — reach out for guidance tailored to your situation.
How to Negotiate the Best Deal When Selling Your Software Company
For many software founders, selling their company is the most consequential financial event of their lives. It’s not just about maximizing valuation — it’s about structuring a deal that reflects the company’s true potential, protects your interests, and sets the stage for long-term success, whether for you, your team, or your product. Negotiating the best deal requires more than a strong pitch deck or a high revenue multiple. It demands strategic preparation, a deep understanding of buyer psychology, and expert guidance throughout the M&A process.
This article outlines the key strategies to help you negotiate the best possible outcome when selling your software company — from pre-market positioning to final term sheet negotiations.
1. Know What “Best Deal” Really Means
Founders often equate the “best deal” with the highest purchase price. But in M&A, value is multidimensional. A $50 million offer with a clean cash close may be far superior to a $60 million offer with a risky earn-out, escrow holdbacks, or equity in a volatile acquirer.
Key components of a strong deal include:
Valuation: Based on EBITDA, ARR, or revenue multiples, depending on your model.
Deal structure: Cash vs. stock, upfront vs. deferred payments, earn-outs, and escrows.
Cultural and strategic fit: Will your team and product thrive post-acquisition?
Post-close obligations: Are you expected to stay on? For how long? Under what terms?
Understanding your priorities — and those of your stakeholders — is the first step in negotiating from a position of strength.
2. Prepare Before You Go to Market
Negotiation leverage is built long before the first buyer call. Sophisticated buyers — whether private equity firms or strategic acquirers — will scrutinize your financials, customer contracts, churn metrics, and codebase. Any red flags can be used to justify a lower offer or more aggressive terms.
Firms like iMerge often conduct a “reverse diligence” process before going to market, identifying and addressing issues that could erode value during negotiations.
3. Create Competitive Tension
One of the most effective ways to improve deal terms is to create a competitive process. When multiple buyers are at the table, you gain leverage — not just on price, but on structure, timing, and post-close terms.
This doesn’t mean blasting your company to dozens of buyers. A targeted, confidential outreach to a curated list of strategic and financial acquirers — often facilitated by an experienced M&A advisor — can generate meaningful interest while preserving discretion.
As we noted in Exit Business Planning Strategy, timing the market and positioning your company to the right buyer pool is critical. A well-run process can add 20–30% to enterprise value, even before formal negotiations begin.
4. Understand the Buyer’s Perspective
Every buyer has a thesis. Strategic acquirers may be looking to fill a product gap, enter a new market, or acquire talent. Private equity firms may be focused on recurring revenue, margin expansion, or bolt-on synergies. Understanding what drives value for them allows you to frame your company in the most compelling light.
For example, if a PE firm is building a vertical SaaS platform, your customer base and integrations may be more valuable than your current EBITDA. In that case, pushing for a higher multiple on ARR — rather than EBITDA — may be more effective.
Advisors like iMerge help founders tailor their positioning to each buyer type, often adjusting the narrative and financial model to align with the acquirer’s investment criteria.
5. Negotiate the Right Terms — Not Just the Right Price
Once you receive a Letter of Intent (LOI), the real negotiation begins. Key terms to focus on include:
Purchase price and structure: How much is paid upfront vs. deferred? Is there an earn-out?
Working capital adjustments: How is net working capital calculated and settled?
Escrow and indemnification: How much of the purchase price is held back, and for how long?
Employment and non-compete terms: Are you required to stay on? What are the incentives?
These terms can materially affect your net proceeds and post-close experience. A skilled M&A advisor will help you model different scenarios and negotiate terms that align with your goals.
6. Don’t Go It Alone
Even the most seasoned founders benefit from experienced deal advisors. M&A is a high-stakes, high-complexity process — and buyers often have teams of lawyers, bankers, and analysts working to protect their interests. You should too.
Firms like iMerge specialize in software and technology transactions, helping founders navigate valuation, deal structuring, and buyer negotiations. From managing the diligence process to avoiding common pitfalls in asset vs. stock sales, the right advisor can add significant value — often far exceeding their fee.
Conclusion
Negotiating the best deal for your software company is about more than just numbers. It’s about understanding your leverage, preparing thoroughly, and aligning the deal structure with your long-term goals. With the right strategy — and the right advisors — you can exit on your terms, with confidence and clarity.
Founders navigating valuation or deal structuring decisions can benefit from iMerge’s experience in software and tech exits — reach out for guidance tailored to your situation.
What Are the Tax Implications of Selling My Software Business?
For many software founders, the sale of their business is the most significant financial event of their lives. But while valuation and deal terms often dominate early conversations, the tax implications of a sale can quietly erode a substantial portion of your proceeds — or, with the right planning, preserve millions in after-tax value.
This article explores the key tax considerations when selling a software business, including deal structure, capital gains treatment, allocation of purchase price, and strategies to optimize your tax position. Whether you’re preparing for an exit or simply planning ahead, understanding these dynamics is essential to maximizing your outcome.
1. Deal Structure: Asset Sale vs. Stock Sale
The structure of your transaction — whether it’s an asset sale or a stock sale — is the single most important driver of your tax liability.
Asset Sale: The buyer purchases individual assets (e.g., codebase, customer contracts, IP, goodwill). This structure is more common in lower middle-market deals and is often preferred by buyers for its tax benefits and liability protection. However, it can result in double taxation for C-corp sellers — once at the corporate level and again when proceeds are distributed to shareholders.
Stock Sale: The buyer acquires the equity of the company. This is generally more favorable for sellers, especially those with C-corp structures, as it typically results in a single layer of taxation at the shareholder level, often at long-term capital gains rates.
For founders with S-corp or LLC structures, the tax impact of an asset sale may be less severe, but still requires careful planning. Firms like iMerge often help clients model both scenarios to understand the net proceeds under each structure.
2. Capital Gains vs. Ordinary Income
Most sellers aim to qualify for long-term capital gains treatment, which is taxed at a federal rate of 15% or 20% (plus the 3.8% Net Investment Income Tax, if applicable). However, not all components of a deal qualify.
Here are some common income types and their tax treatment:
Goodwill and equity sale proceeds: Typically taxed as long-term capital gains if held for more than one year.
Earn-outs tied to performance: May be taxed as capital gains or ordinary income depending on structure and contingencies. Earn-out structuring is a nuanced area that can significantly affect your tax bill.
Compensation for services (e.g., consulting agreements, non-compete payments): Taxed as ordinary income and subject to payroll taxes.
Misclassifying income can lead to unnecessary tax exposure. A seasoned M&A advisor and tax counsel can help ensure the deal is structured to preserve capital gains treatment wherever possible.
3. Allocation of Purchase Price
In an asset sale, the IRS requires that the purchase price be allocated across various asset classes (IRC Section 1060). This allocation affects both the buyer’s depreciation/amortization schedule and the seller’s tax liability.
For example:
Allocation to tangible assets (e.g., equipment) may trigger depreciation recapture, taxed as ordinary income.
Allocation to intellectual property or customer lists may be taxed at capital gains rates, depending on how they were developed and held.
Allocation to goodwill is generally favorable for sellers, as it qualifies for capital gains treatment.
4. Qualified Small Business Stock (QSBS) Exclusion
One of the most powerful — and often overlooked — tax planning tools is the Section 1202 Qualified Small Business Stock (QSBS) exclusion. If your C-corp meets certain criteria and you’ve held the shares for at least five years, you may be eligible to exclude up to $10 million (or 10x your basis) in capital gains from federal taxes.
QSBS eligibility depends on several factors, including:
Original issuance of stock (not secondary purchases)
Gross assets under $50 million at the time of issuance
Active business requirements (e.g., at least 80% of assets used in qualified trade)
Founders who proactively structure their equity and maintain proper documentation can unlock significant tax savings. iMerge often works with clients and their tax advisors to assess QSBS eligibility early in the exit planning process.
5. State and Local Taxes
While federal taxes often take center stage, state and local taxes can materially impact your net proceeds. For example, California taxes capital gains as ordinary income, with top rates exceeding 13%. In contrast, states like Florida and Texas have no personal income tax.
Some founders consider relocating prior to a sale, but the IRS and state tax authorities scrutinize such moves closely. Timing, intent, and documentation are critical. A rushed or poorly executed relocation strategy can backfire, triggering audits or penalties.
6. Timing and Tax Law Changes
Tax policy is fluid. Proposed changes to capital gains rates, corporate tax rates, or QSBS rules can materially affect your exit strategy. As we noted in Tax Law Changes and the Impact on Personal Taxes from Selling a Software Company, timing your sale in anticipation of legislative shifts can be a strategic lever — but it requires careful monitoring and flexibility.
7. Planning Ahead: Tax Optimization Strategies
Effective tax planning should begin well before you enter the market. Here are a few strategies to consider:
Entity restructuring: Converting to a C-corp early may unlock QSBS benefits down the road.
Installment sales: Spreading payments over multiple years can defer and smooth tax liabilities.
Charitable trusts or donor-advised funds: Gifting shares pre-sale can reduce taxable estate and generate deductions.
Family gifting strategies: Transferring shares to family members in lower tax brackets can reduce overall tax burden.
Each strategy carries trade-offs and compliance requirements. A coordinated approach between your M&A advisor, tax counsel, and financial planner is essential.
Conclusion
Taxes are not just a post-closing footnote — they are a central pillar of your exit strategy. The difference between a well-structured and poorly structured deal can be measured in millions. Founders who engage early with experienced advisors are best positioned to preserve value and avoid surprises.
Founders navigating valuation or deal structuring decisions can benefit from iMerge’s experience in software and tech exits — reach out for guidance tailored to your situation.
For software founders contemplating an exit, one of the first questions that arises is deceptively simple: how long will it take to sell my company? The answer, as with most things in M&A, is: it depends. But with the right preparation and advisory support, the timeline can be managed strategically to align with your goals — whether that’s maximizing valuation, minimizing disruption, or closing before year-end.
This article breaks down the typical timeline to sell a software company, the key phases involved, and the variables that can accelerate or delay the process. We also offer insights from iMerge’s experience advising software and SaaS founders through successful exits.
Typical Timeline: 6 to 12 Months from Start to Close
On average, the sale of a software company takes 6 to 12 months from initial preparation to final closing. However, this range can vary significantly based on company size, deal complexity, buyer type, and market conditions.
Here’s a high-level breakdown of the phases:
Pre-Market Preparation (1–3 months): Financial cleanup, data room assembly, positioning, and valuation analysis.
Go-to-Market & Buyer Outreach (2–4 months): Engaging strategic and financial buyers, managing NDAs, and fielding initial interest.
Negotiation & LOI (1–2 months): Term sheet discussions, exclusivity, and selection of the lead buyer.
Due Diligence & Closing (2–3 months): Legal, financial, and technical diligence, followed by final documentation and closing.
While some smaller SaaS businesses can transact in under six months, larger or more complex deals — especially those involving international buyers, regulatory approvals, or earn-outs — may take longer.
Factors That Influence Deal Timeline
Several variables can meaningfully impact how long it takes to sell a software company:
1. Company Readiness
Companies that have completed pre-LOI due diligence, maintain clean financials, and have clear customer contracts are far more likely to move quickly through the process. Conversely, if a buyer uncovers gaps in documentation or unclear IP ownership, the timeline can stretch by months.
2. Buyer Type
Strategic buyers (e.g., larger software firms) often move faster when there’s a clear product or market fit. Private equity buyers, on the other hand, may require more extensive diligence and internal investment committee approvals. In iMerge’s experience, PE-led deals tend to take longer but can offer more flexible structures.
3. Deal Structure
Asset sales vs. stock sales, earn-outs, rollover equity, and working capital adjustments all add complexity. As we’ve discussed in Asset versus Stock Sale, the structure you choose can materially affect both the timeline and tax implications.
4. Valuation Alignment
Misalignment on valuation expectations is one of the most common causes of deal delays or failures. Founders who enter the process with a realistic understanding of valuation multiples for software companies are better positioned to negotiate efficiently and avoid protracted back-and-forth.
5. Market Timing
Broader M&A market conditions — including interest rates, public SaaS multiples, and buyer appetite — can influence how quickly buyers move. In periods of volatility, even well-prepared companies may face longer timelines as buyers become more cautious.
Case Study: A Mid-Market SaaS Exit in 8 Months
Consider a fictional but representative example: a $12M ARR vertical SaaS company with 90% gross margins and 110% net revenue retention. The founder engaged iMerge to explore a sale after receiving inbound interest from a strategic acquirer.
After a 6-week preparation phase — including financial recasting, KPI benchmarking, and buyer materials — iMerge launched a targeted outreach process. Within 60 days, the company received three LOIs, ultimately selecting a private equity-backed platform buyer offering a 7.5x ARR multiple with partial rollover equity.
Due diligence took another 10 weeks, with legal and tax structuring adding complexity due to international operations. The deal closed in just under 8 months from kickoff — a timeline made possible by early preparation and experienced advisory support.
How to Accelerate the Process
While some factors are outside your control, there are several ways to reduce friction and shorten the timeline:
Start early with exit planning — even 12–18 months before a desired sale window. This allows time to optimize KPIs, clean up financials, and address any red flags.
Work with an experienced M&A advisor who understands the software landscape and can manage buyer outreach, diligence, and negotiations efficiently.
Prepare a robust data room in advance, including financials, contracts, IP documentation, and customer metrics. See our Top 10 Items to Prepare When Selling Your Website for a helpful checklist (equally applicable to SaaS).
Align internal stakeholders — including co-founders, board members, and key employees — to avoid delays during decision points.
Final Thoughts
Selling a software company is not a sprint — but it doesn’t have to be a marathon either. With the right preparation, realistic expectations, and experienced guidance, most founders can navigate the process in 6 to 12 months. The key is to treat the sale as a strategic process, not a reactive event.
Firms like iMerge specialize in helping software and SaaS founders manage this journey — from valuation and positioning to buyer negotiations and closing. Whether you’re exploring a full exit or partial liquidity, the timeline can be tailored to your goals with the right team in place.
Founders navigating valuation or deal structuring decisions can benefit from iMerge’s experience in software and tech exits — reach out for guidance tailored to your situation.
