What is an earnout?
An earnout is a portion of the purchase price that a buyer agrees to pay the seller only if the acquired business hits specified performance targets after the deal closes. Instead of one fixed price at signing, the consideration is split into an upfront amount and a contingent amount tied to future results.
Earnouts exist to bridge a valuation gap. The seller believes the business will grow and wants to be paid for that growth; the buyer is unwilling to pay today for performance that may not materialize. The earnout lets both sides agree to close by making part of the price conditional on what actually happens.
The targets are usually financial — revenue, EBITDA, or gross profit over a defined period — but can also be milestone-based, such as a product launch, a regulatory approval, or customer retention. The mechanics live in the purchase agreement and are heavily negotiated.
How an earnout actually works
An earnout is defined by a handful of negotiated terms that together determine whether and how much the seller is paid.
- The metric. What is measured — revenue, EBITDA, gross margin, or a non-financial milestone. EBITDA-based earnouts invite the most disputes because the figure is sensitive to accounting choices.
- The target and period. The threshold that must be met and the window over which it is measured, commonly one to three years post-close.
- The payout structure. Whether the payment is all-or-nothing at a threshold, linear above a floor, or capped at a maximum — and how partial achievement is treated.
- The protective covenants. Rules on how the buyer must operate the business during the earnout period, so it cannot suppress the metric to avoid paying.
Because the seller often stays on to run the business during the earnout, alignment is built in — but so is the risk of conflict when the buyer's broader strategy diverges from the metric being measured.
Where earnouts go wrong
Earnouts are a frequent source of post-close litigation. The core problem is control: after close the buyer runs the business, but the seller's payment depends on how it performs. If the buyer cuts marketing, reallocates resources, integrates the unit, or changes accounting, the metric can fall even if the underlying business is healthy.
Well-drafted earnouts anticipate this with operating covenants, agreed accounting methodologies, and dispute-resolution mechanics. The cleanest metric is usually revenue or a non-financial milestone, since both are harder to manipulate than a margin figure that depends on cost allocations.