Valuation gaps emerge when buyers and sellers disagree on the value of a company and are often seen as a deal-breaker. In practice, it is more often a structuring problem to be solved. Sellers see the years of effort that built the company and the growth still ahead. Buyers see the same opportunity through a more conservative lens often placing more emphasis on what has been achieved and can be underwritten with confidence.
When those views do not align, a transaction can stall. But a valuation gap does not always mean the deal is dead. It often means the structure needs to close the gap.
Deal structure – earnouts, holdbacks, seller notes, rollover equity, and deferred consideration – can bridge the gap between what a seller wants and what a buyer is prepared to pay at closing. Well executed, these tools preserve upside for sellers while protecting buyers from overpaying for performance not yet materialized.
Why Valuation Gaps Happen
Buyers and sellers often have a different outlook on the growth profile of a company and/or the probability of achieving that growth. Sellers may believe the business deserves credit for new products, customers, or margin initiatives already underway or to be implemented. Buyers could agree but still hesitate to pay full value upfront for growth that has not as yet been achieved.
Market conditions and uncertainty can widen the gap. Higher financing costs, more selective lenders, and tighter underwriting limit how far buyers will stretch, especially when part of the growth story remains unproven.
This is where deal structure becomes important. Rather than forcing both sides to agree on one fixed number at closing, structure allows value to be determined over time, based on how the business actually performs.
Earnouts: Paying for Performance After Closing
Earnouts are the most common tool used to bridge valuation gaps. Utilization of earnout structures and consideration tied to them are on the rise. 24% of M&A deals completed in 2025 included an earnout (excluding Life Sciences deals), compared with 22% of the deals completed in 2024. A portion of the price is paid after closing if the business hits agreed milestones which most often include financial metrics such as revenue and EBITDA. If the seller’s forecast proves correct, the seller receives additional value. If it doesn’t, the buyer is protected from overpaying.
Earnouts are especially useful when the business has forecast considerable growth which could be as a result of a strong pipeline, recent customer wins, a new product launch, or margin initiatives that are credible but not yet in historical financials.
But structuring has to be right. The metric must be clear, the measurement period realistic, and the accounting defined. The seller needs to understand how much control they retain; the buyer needs flexibility to operate without being boxed into decisions designed only to maximize the earnout. Poorly structured earnouts create conflict. Well-structured ones convert disagreement into alignment.
Holdbacks and Escrows: Protecting Against Unknowns
Buyers rarely pay the full purchase price at closing – even after diligence. A portion is typically reserved against post-closing risks that have not yet surfaced: undisclosed liabilities, working capital adjustments, indemnification claims, customer concentration concerns, or litigation exposure. There are two structurally different ways to do this.
A holdback is when the buyer simply withholds a portion of the price. The funds remain with the buyer until release conditions are met. It is administratively simple but seller-unfriendly: the seller is relying on the buyer’s willingness to pay, and any dispute defaults to the buyer’s hold.
An escrow moves the same funds to a neutral third party – typically an escrow agent – who releases them according to pre-agreed terms. Escrows are far more common in middle-market M&A. SRS Acquiom’s 2025 deal-term commentary noted that more than three-quarters of deals included a special-purpose escrow for purchase price adjustments, while nearly three out of ten included a special-purpose escrow for stand-alone indemnity matters such as taxes or ongoing litigation.
For sellers, the trade-off in either structure is the same: delayed access to proceeds and uncertainty around final economics. But the mechanics differ meaningfully. A well-structured escrow with a reasonable release period and objective release mechanics keeps the transaction moving. A vague holdback with broad release conditions becomes a disguised price reduction.
Earnouts allocate upside. Holdbacks and escrows allocate risk. Both buy time for trust to be earned.
Seller Financing: Sharing Risk Through a Seller Note
Seller financing can also bridge a valuation gap. The seller finances a portion of the price through a note the buyer repays over time, often with interest. This reduces the cash required upfront and is useful when traditional financing is constrained, when the buyer wants to preserve liquidity or resources, or when both sides need flexibility to complete the deal.
However, seller financing introduces credit risk. The seller is no longer just exiting; they are extending financing to the buyer. Terms matter: interest rate, maturity, amortization, security, subordination, covenants, and remedies on default. The issue is not only how much is promised, but how likely it is to be collected.
Rollover Equity: Staying Invested in the Next Chapter
Rollover equity is common in private equity and increasingly important in the middle market. GF Data reported that 68.3% of completed platform buyouts through Q3 2025 included seller rollover equity, averaging 14.8% of total enterprise value. The seller reinvests a portion of proceeds into the post-closing entity, retaining an ownership stake. This bridges valuation gaps by letting the seller participate in future upside rather than requiring the buyer to pay for all future value at closing.
Rollover equity aligns incentives – a seller who remains invested has a continued interest in the company’s success – and can give the seller a “second bite at the apple” if the business is sold again at a higher valuation. It is particularly compelling when the buyer brings what the seller does not have today: capital, professionalized systems, broader customer access, or operational scale.
Rollover equity should be evaluated carefully. Sellers need to understand the rights attached to their equity, capital structure, governance terms, dilution risk, and exit timing.
Deferred and Staggered Payments: Giving the Deal Time to Prove Itself
Some valuation gaps are really timing gaps. The seller believes value will increase shortly because of a pending contract, expansion, product launch, or market recovery. The buyer may agree but not want to pay today for an event that has not yet occurred.
Deferred or staggered payment structures solve this. A portion is paid at closing, with additional payments scheduled over time or tied to specific milestones – a contract renewed, a permit obtained, or a backlog converting into revenue. These are simpler than earnouts when the issue is a specific event rather than broad performance.
The benefit is flexibility. The risk is ambiguity. Milestones need to be objective, documented, and difficult to manipulate.
Matching the Tool to the Problem
The right structure depends on the source of the valuation gap.
- If the issue is future growth, an earnout or rollover may fit.
- If the issue is financing capacity, a seller note or preferred equity may help.
- If the issue is diligence risk, a holdback, escrow, or insurance solution is usually more appropriate.
- If the issue is tax efficiency, legal and tax structure may matter as much as the headline price.
Buyer type also matters. Private equity buyers tend to be more familiar with rollover equity, seller notes, and
structured incentives – tools that align management and reduce upfront cash. Strategic buyers tend to
focus on integration, customer retention, IP, or milestone-based payments tied to specific events. The same
business may attract very different structures depending on the buyer universe.
Deal structuring is not a late-stage legal exercise. It is part of transaction strategy, and advisors add the most value when involved before major terms become difficult to revisit.
How Sellers Should Evaluate Non-Traditional Structures
For sellers, the appeal of these structures is clear – they can support a higher purchase price and keep a deal alive that might otherwise fall apart. But headline value is not the same as certain value. Before accepting a specific structure, sellers should ask:
1. What risk is this structure solving?
Is it addressing growth uncertainty, financing limitations, diligence concerns, or post-closing alignment? A structure should have a purpose.
2. How much of the value is paid at closing?
Cash at close and contingent value are not the same. A higher headline price with significant deferral may be less attractive than a lower price with greater certainty.
3. Who controls the outcome after closing?
If future payments depend on business performance, the seller needs to understand who will control pricing, hiring, customer decisions, and strategic priorities.
4. Does the structure align with the seller’s goals?
Some sellers want maximum cash at closing. Others are comfortable participating in future upside. The right answer depends on risk tolerance, liquidity needs, and post-closing role.
Conclusion
Valuation gaps do not always need to end a transaction. With the right structure, buyers and sellers can find a path that balances risk, reward, and timing – but only when the structure is clear, fair, and tied to the real issue in the deal. For sellers, preparation creates leverage: the clearer the growth story is in data, the more organized the diligence, and the more competitive the process, the more buyers improve not only price but structure.
The takeaway is simple: the best offer is rarely the highest headline price. It is the offer that delivers the best combination of value, certainty, and execution.
If you are considering a transaction and want to understand how deal structure could impact value, Harney Capital can help you evaluate the options, negotiate the terms, and position your business for a successful outcome.
Sources
- Deal Lawyers
- GF Data
- SRS Acquiom
