What is an Earnout?

An earnout is a contingent portion of the purchase price in an M&A transaction. Instead of paying you the full price at closing, the buyer agrees to pay an additional amount over time — contingent on the acquired business hitting specified performance targets after closing.

Typical earnout periods run 1–3 years; targets are most commonly tied to revenue, EBITDA, or customer-retention metrics; structures vary from simple (‘hit $5M revenue in Year 1 = $1M payment’) to complex (sliding-scale formulas with multiple variables).

Buyers often propose earnouts to bridge valuation gaps — when the seller believes future growth justifies a higher price than the buyer is willing to pay upfront. The earnout effectively says: ‘if you’re right about the growth, you’ll get the higher price; if you’re wrong, you won’t.’ That can be reasonable, or it can be a way to claw back value you thought you’d already won.

Common Earnout Structures

Revenue-based earnouts

Payment triggered by hitting a revenue threshold. Simplest structure but problematic for sellers because it doesn’t account for whether the buyer maintains margins. Buyers can hit revenue targets via low-margin growth that hurts the business overall — without paying you more.

EBITDA-based earnouts

Payment triggered by hitting an EBITDA threshold. Better aligned to actual profitability. But contentious because the buyer controls operations post-close — new owner cost allocations, parent-company overhead pushes down, or strategic investments can suppress earnout-period EBITDA.

Hybrid / sliding-scale earnouts

Earnout amount scales with how far above (or below) the target the actual results land. More common in larger deals; reduces the cliff effect where missing a target by $1 costs you the entire earnout payment.

Performance-milestone earnouts

Triggered by specific events (renewing a major contract, hitting a regulatory milestone, completing a product launch). Common in healthcare, technology, and services with binary outcomes.

Earnout Pitfalls for Sellers

Loss of operational control

Once the buyer owns the business, they make the decisions — pricing, hiring, customer focus, investment. If their decisions hurt earnings during the earnout period, you bear the cost. Even well-intentioned strategic changes (entering new markets, investing for the long term) can suppress earnout-period results.

Cost allocation games

Buyers can allocate parent-company overhead, new corporate-services costs, or shared resources to the acquired business — depressing reported earnings. Unless the earnout agreement specifically prohibits or caps these allocations, sellers can lose payment they would otherwise have earned.

Accounting and audit disputes

Disputes over what counts as ‘earnout-period EBITDA’ are common. Was that customer churn caused by the buyer’s pricing change or the seller’s prior service issues? Was that one-time expense really one-time? Sellers should require audit rights and dispute-resolution procedures in the earnout agreement.

Buyer financial deterioration

If the buyer themselves struggles financially during the earnout period, even fully-earned payments can be at risk. For private buyers especially, the value of the earnout depends on the buyer’s continued ability and willingness to pay.

Earnout Best Practices

If you’re going to accept an earnout, structure it to minimize the most common problems:

• Tie to metrics you can actually influence. If you’re staying as an operator post-close with autonomy, EBITDA-based earnouts can make sense. If the buyer is taking over operations completely, revenue or simpler milestone-based earnouts often work better.
• Cap parent-company allocations. Specify what (if anything) the buyer can allocate to the acquired business during the earnout period.
• Require audit rights. You should be able to verify earnout calculations through access to financial records and (if needed) an independent auditor.
• Include a dispute-resolution mechanism. Typically a defined procedure plus an independent arbitrator for disputed amounts.
• Negotiate the basket. Don’t accept ‘all or nothing’ cliffs — structure pro-rata or sliding-scale payouts.
• Consider acceleration clauses. If the buyer sells, takes the company public, or terminates your employment, the full earnout often should accelerate.
• Don’t accept an earnout as the bulk of the price. If 50%+ of your ‘price’ is earnout, you haven’t really sold the business — you’ve taken on continued business risk without continued control. Aim for earnout as ~10–25% of total deal value, not more.