💰 What Is an Earnout?
An earnout is a contractual provision in M&A or private equity deals where part of the purchase price is contingent on the business achieving specific performance targets after the deal closes.
An earnout is a contractual provision in M&A or private equity deals where part of the purchase price is contingent on the business achieving specific performance targets after the deal closes.
In simple terms:
"We’ll pay you $100M total for your business—$80M now, and the other $20M if you hit revenue or profit goals over the next 1–3 years."
🔍 Why Use an Earnout?
Earnouts are most common when:
There’s a valuation gap between buyer and seller
The business is growing, but future performance is uncertain
The buyer wants to keep the founding team engaged post-acquisition
Earnouts reduce the buyer's risk and incentivize performance from the seller post-transaction.
📊 Common Earnout Structures
1. Performance Metrics
Revenue (e.g., $50M in sales by Year 2)
EBITDA / Net Profit
Product launches, customer KPIs, or margin thresholds
2. Measurement Period
Usually 1 to 3 years post-close
3. Payout Terms
Flat, tiered, or pro rata
Capped at a max amount (e.g., $25M)
4. Payment Type
Cash, equity, or debt instruments
🛠️ Real-World Example
Total purchase price: $100M
Upfront payment: $75M
Earnout: $25M over 3 years, tied to revenue targets
Year Revenue Target Earnout Payout 1 $20M $5M 2 $25M $8M 3 $30M $12M
🤝 Seller vs. Buyer Perspective
Aspect Seller View Buyer View Motivation Keeps skin in the game Encourages continued performance Valuation Disagreement Helps close valuation gap Mitigates risk of overpaying Risk Payment uncertainty Less upfront cash outlay Control May lose control post-close Could be incentivized to "manage" earnout outcomes
⚠️ Pitfalls & Risks
Loss of operational control can limit seller’s ability to hit earnout targets
Accounting manipulation (inflated expenses, reallocated costs)
Disputes over measurement or reporting
Legal costs if disagreements escalate
🧠 Best Practices
Define all terms clearly
Standardize accounting practices (e.g., GAAP-based)
Agree on decision rights (especially budget, hiring, product)
Include governance mechanisms (e.g., joint earnout committee)
📜 Sample Earnout Clause
Here’s a simplified example of an earnout clause that could appear in a purchase agreement:
Section 2.4 – Earnout Consideration
(a) Earnout Payment. In addition to the Closing Payment, Buyer shall pay to Seller an additional amount of up to $25,000,000 (the “Earnout Payment”), based on the achievement of certain revenue milestones during the Earnout Period, as defined below.
(b) Earnout Period. The Earnout Period shall commence on the Closing Date and continue for three (3) consecutive 12-month periods thereafter (each, a “Measurement Year”).
(c) Milestone Targets and Payments:
If Gross Revenue for Measurement Year 1 equals or exceeds $20,000,000, Seller shall receive $5,000,000;
If Gross Revenue for Measurement Year 2 equals or exceeds $25,000,000, Seller shall receive $8,000,000;
If Gross Revenue for Measurement Year 3 equals or exceeds $30,000,000, Seller shall receive $12,000,000.
(d) Payment Terms. Earnout Payments shall be made within 90 days after the end of each Measurement Year and shall be paid in cash.
(e) Accounting Methodology. Revenue shall be calculated in accordance with GAAP, applied consistently with Seller’s historical practices.
(f) Control and Cooperation. Buyer shall operate the Company in good faith and not take any actions that are intended to materially reduce or avoid Earnout Payments.
(g) Dispute Resolution. In the event of a disagreement regarding Earnout calculations, the parties agree to appoint a neutral accounting firm whose decision shall be final and binding.
✅ Summary
Earnouts are powerful deal tools to:
Align post-acquisition incentives
Bridge valuation gaps
Mitigate risk for the buyer
Reward sellers for future performance
But they also require clear structure, good governance, and trust. Handled poorly, earnouts can lead to conflict or litigation.