Earnouts, Rollover Equity and Seller Notes in 2026 - Using Structure to Bridge the Gap

Adapted from the AM&AA Edge webinar "Earnouts, Rollovers & Seller Notes in 2026: Structuring and Negotiating the Deal," presented by Xavier Staggs, Senior M&A Advisor at The Raivax Group. Watch the full session here: https://youtu.be/rt5qLOLpek4

In the lower middle market, the highest number rarely wins the deal — the smartest structure does. Earlier this year, as interest rates calmed, valuation gaps narrowed and some of the pressure came off. Then rates ticked back up, the disparity between buyer and seller expectations widened again, and structure went right back to doing the heavy lifting. Earnouts, seller notes, and rollover equity are being used more than ever to get deals across the finish line. The challenge is designing them so they actually pay out as intended — instead of becoming the next post-closing dispute.

Here is a practitioner's walk-through of the three tools, what's "market" in 2026, how to build an earnout that holds up, and three live deals that show the ideas in action.

The three tools, in plain terms

Earnouts deliver additional consideration to the seller based on something that happens after closing. They bridge a disagreement about the future — "prove it, and you'll get paid."

Seller notes are the seller financing part of the purchase price. They primarily bridge a financing gap when the buyer can't bring the full price in cash, but they also help close valuation gaps and can keep a seller incentivized through a transition or consulting period.

Rollover (or retained) equity is the seller reinvesting part of the enterprise value back into the ongoing business. If the acquired operations are folded into a buyer's entity and the seller takes a percentage of that larger entity, that's a rollover. If the seller keeps a slice of the company being acquired, that's retained equity. Either way, it aligns incentives and sets up a "second bite of the apple" at the next exit.

In practice, you rarely use just one. Most 2026 structures blend two or three.

What's "market" in 2026 — a lower-middle-market lens

•     Earnouts show up in roughly 24–25% of all deals. In the lower middle market the frequency is lower — but when an earnout is used, it often represents a very significant portion of the purchase price. Revenue has become the leading metric, with a measurement period around 24 months.

•     Rollover / retained equity appears in about 64% of middle-market private-equity deals, typically 10–30% of the price — the classic second-bite setup.

•     Seller financing is the workhorse of lower-middle-market LOIs — present in roughly 60% of deals market-wide, and closer to 90% of the deals I've closed this year.

SBA-backed deals carry their own rules, which thread through all three tools — more on that below.

Designing an earnout that actually pays

An earnout comes down to six parts: the metric, the period, the threshold and target, the payout formula and cap, the covenants, and the measurement-and-dispute mechanism. The metric and the covenants are where you'll spend most of your time.

Choosing the metric — and knowing whose risk it carries. This is the most consequential choice, and the key is to see which party bears the risk of the number moving:

•     Revenue sits at the top of the income statement. It's clean, easy to measure, and hard for a buyer to suppress — which is why sellers like it. The catch lands on the buyer: chasing growth can mean "buying" revenue through heavy sales-and-marketing spend that drops EBITDA even as the top line climbs. So the buyer can end up paying an earnout on unprofitable revenue.

•     EBITDA is closest to enterprise value and is the metric I see most often — but it flips the risk to the seller, because a buyer can suppress EBITDA far more easily than revenue.

•     Gross profit sits in the middle, and works best in commodity-type businesses with many suppliers and stable costs; where cost of goods swings widely, it's hard to use.

•     Milestones are binary: a defined future event either happens or it doesn't, and the earnout is paid or not.

When an earnout actually fits. Sellers often say, "I've set this company up perfectly — it just needs a little time to take off, and I want to share in that growth." Buyers counter, "It's my resources, cash, and expertise that will drive the growth, so I should keep the benefit." Both are right, which is why earnouts work best in two situations: (1) when the seller stays involved and actively drives the metric — maintaining a key relationship or running sales — or (2) when the seller has already put the pieces in place and the buyer essentially needs to keep the lights on. Earnouts struggle when the returns will clearly come from the buyer's work; paying the seller for the buyer's effort is a hard pill to swallow.

Good vs. bad design. A good earnout starts with a defined EBITDA and an agreed add-back schedule; a bad one I've actually seen proposed was "a percentage of net profit" — with no definition of net profit. Pair the metric with covenants and control: require the business to be run consistent with past practice during the earnout period, and, where possible, let the seller keep operational control of the base metrics. The opposite — full buyer discretion and immediate integration that intertwines the acquired operations — makes the metric nearly impossible to measure. Keep the length short (one to two years; four or five years out, who knows what happens), and spell out the dispute process, ideally with an independent accountant named in advance.

How weak metrics get gamed. Give a buyer an undefined EBITDA target over three or four years and there are legal ways to make the number disappear: shift revenue to an affiliate, stack overhead onto the earnout unit, or time big equipment purchases and special depreciation to crush earnings in the measurement year. None of it is fraud — it's unmanaged discretion. The fix is strong, well-drafted covenants and a tightly "fenced" definition of the unit and the metric.

Seller notes and rollover: the essentials

On seller notes, watch subordination (they'll sit behind senior lending), security (also subordinated — but push for junior liens on equipment or real estate and personal guarantees), and set-off rights (a buyer's ability to net indemnity claims against the note). Indemnity claims are hard to enforce and collect, so limiting set-off gives a seller real comfort. And don't assume a note is always "prime-plus, three-to-five-year amortization" — rate and amortization are levers. On a recent call, a buyer proposed a 3% rate the seller balked at, until you see the buyer was also paying 8–9x EBITDA where the market was 5x. Terms interact.

On rollover, focus on two things your sell-side clients will raise before you do: favorable tax treatment (deferring gain — get tax counsel and CPAs in at the LOI stage) and minority protections (anti-dilution, information rights, and the like, since your client becomes a minority holder).

The SBA wrinkle on retained equity. Under the current SBA rules, a seller can retain equity — but any retained equity requires the seller to personally guarantee the SBA loan for at least two years, and if they keep more than 20%, the guarantee runs for the life of the loan. That single fact has ended more than one seller's interest in rolling equity this year. A common workaround is phantom equity — a profits interest in an LLC rather than a membership interest — which gives the seller a share of profits without the ownership that triggers the guarantee.

Make sure it can actually be financed

You can put on your engineering hat and design a structure that solves every buyer and seller concern — and still fail if the lender or investment committee won't accept it. Lenders require any seller-note portion used as an SBA equity injection to be on full standby for the life of the loan, won't allow earnouts that impair debt service or trip cash-flow covenants, and care about the security of the primary loan versus the seller note. Investment committees want the seller properly aligned for a smooth transition and want earnouts tied to value creation (adjusted EBITDA) rather than just revenue. On the sell side, one of our biggest jobs is negotiating a deal that can close — and doing it early, because a signed LOI that can't be financed leaves you renegotiating from a weak position.

Three deals, three structures

1. The engine dealership that couldn't be confirmed. A commercial engine sales-and-service company drew significant value from one manufacturer's dealership — valuable, though not the whole business, and specifically important to the buyer. We spent months trying to get the manufacturer to confirm the buyer could keep it, and got nowhere; the answer was "close the deal, apply, and we'll let you know." Both sides still wanted to do the deal, so we priced the uncertainty: we agreed what the business was worth with the dealership and without it, then built a binary milestone earnout around obtaining the license. We closed, with a 12-month term and heavy legal language requiring the buyer to file timely, respond to requests, and diligently pursue the license — so the buyer couldn't drag its feet to month twelve-and-one-day. The deal also included seller financing, and the owner stayed on in an incentivized sales role.

2. The manufacturer about to double EBITDA. A solid company with mid-seven-figure EBITDA had built a new manufacturing line projected to roughly double earnings on a new product launch. The seller argued the pieces were all in place — written indications of interest, if not yet purchase orders — so it was reliable. The buyer's position: prove it, or I'll pay when I see it. We're building an earnout that pays as those projections materialize, while wrestling with the real questions: at what point does the growth become the buyer's effort, and what metric to use when the new line shares overhead with existing lines (perhaps something other than EBITDA). The deal also includes rollover equity, which lets the seller benefit from the upside as an owner and keeps them motivated so the buyer can't starve the new line to depress the earnout.

3. The professional-services firm with two contracts. About 80–85% of revenue came from just two contracts — a real concentration risk — and the deal was SBA-financed, right at the top of the lender's threshold. The SBA doesn't permit "earnouts," so we used a forgivable seller note instead: the note (25% of the deal) is reduced if one of the two contracts is terminated or not renewed within two years of closing, protecting the buyer from a devastating early revenue loss without putting the full 85% at risk. Part of the note serves as the buyer's equity injection, so that portion sits on full standby for the seven-year SBA term. The seller wanted to participate but didn't want to personally guarantee the loan, so we're using phantom equity to give them a share of profits without triggering the guarantee.

How the money actually moves

Earnouts are funded by the metric: an EBITDA-based earnout comes out of the business's future cash flow, while a binary milestone can be pre-funded into escrow — or, as in the engine deal, simply paid (there, via a seller note over two years) when the trigger is hit. Seller notes are adjusted through set-off, forgivability, and rate/amortization. Rollover is straightforward math: keep 10–30% of your entity, or, when operations integrate into the buyer, convert your retained value into a percentage of the larger post-close entity.

Getting it right with legal

The advisor owns the commercial terms — the structure, the metrics, the covenants, and the read on each party's concerns and risk appetite. You work with counsel on definitions, covenants, security, and set-off, and you let counsel own the drafting, the subordination documents, the dispute mechanism (make sure the client understands it), and confirming the tax structure is actually achievable. The through-line of the whole hour was simple: define, define, define — and bring good M&A counsel in early, so they understand where you're headed and can put exactly what you agreed onto paper. Counsel's toolkit includes efforts standards ("best efforts," "commercially reasonable efforts," "good faith") and anti-bad-faith language that make covenants enforceable.

From the Q&A

•     Do earnouts cap the upside or accelerate it? Almost always a cap — investment committees want certainty in underwriting. One deal this year would have paid three times more without its cap.

•     How many earnouts actually pay out? In my experience, about half. Milestone earnouts can be built to pay; performance-based ones depend heavily on how qualified the buyer is — another reason it helps to keep the seller involved.

•     Are earnouts allowed in SBA deals? Not as "earnouts" — but forgivable seller notes are, and lenders will underwrite them (as in deal three).

•     What is phantom equity? A profits interest in an LLC, not a membership interest — which is why it doesn't trigger the SBA personal guarantee.

•     Biggest red flag for a future dispute? A seller who exits completely at closing while the metrics ride entirely on business performance — especially when there's little confidence the buyer can grow it.

The takeaways

Identify the specific risk, put a price on it, and structure around it — don't wait for a certainty that may never come. Put the risk and the reward on the party best able to manage it. Define the metrics, triggers, and covenants with precision. And make sure whatever you design can actually be financed and closed. Just because a result lives in the future doesn't mean you can't close today with a structure that's fair no matter how that future turns out.

Want to talk through a structure on a live deal? Reach out to Xavier Staggs at The Raivax Group — and watch the full AM&AA Edge session at https://youtu.be/rt5qLOLpek4.