Earnout
A deal structure where part of the purchase price is contingent on the business hitting defined performance targets after the sale closes.
What is an Earnout?
An earnout is a performance-based payment. Instead of paying the full agreed price at closing, the buyer pays an additional amount — the earnout — if the business hits specified financial or operational targets after the sale.
Example: A business sells for $3M base price + up to $1M earnout if revenue exceeds $2M in each of the next two years post-close.
Why Earnouts Exist
Earnouts bridge valuation gaps between buyers and sellers. When a seller believes the business will keep growing but the buyer isn't willing to pay for future performance upfront, an earnout lets them share the risk.
Common situations where earnouts appear:
- Business has high growth that hasn't proven sustainable yet
- Business is heavily dependent on the owner (buyer wants to see the transition succeed)
- Buyer and seller disagree on future growth projections
- Revenue concentration in a few customers with renewal uncertainty
The Problem With Earnouts
Earnouts are the most contentious clause in M&A deals. After closing, the buyer controls the business. If they:
- Cut marketing spend
- Change pricing
- Deprioritize the acquired business in favor of other products
- Move the business into a different reporting structure
...the seller may not hit their targets through no fault of their own.
The rule of thumb: Cash at close beats earnout every time. A lower guaranteed price is often worth more than a higher price with a large earnout.
How to Protect Yourself in an Earnout
If you must accept an earnout:
- Define the metric precisely (net revenue, EBITDA, specific product revenue)
- Set an accounting methodology in writing
- Require the buyer to maintain the business's operating structure
- Cap the buyer's ability to cut investment in the business
- Get a personal guarantee from the buyer if possible
- Include an acceleration clause if the buyer sells the business before the earnout period ends
Earnout vs. Seller Note
A seller note is a fixed debt obligation — the buyer owes the money regardless of performance. An earnout is contingent — you only get paid if targets are hit. From a seller's perspective, a seller note is generally safer.