October 23, 2026
An earnout is part of the purchase price that the buyer pays later, only if the business hits agreed targets after closing. It bridges a gap between what you think the company is worth and what the buyer will pay today. Earnouts are among the most frequently disputed terms in private company deals because the buyer controls the business while you wait for the money, so the terms that matter are the metric, the payout formula, the operating covenants, acceleration and how disputes get resolved. Treat the earnout as upside, not as price.
Key takeaways
A buyer offers an earnout when it won't pay your price for a business it can't yet verify. You say revenue will double next year; the buyer says prove it. An earnout lets both sides sign at the buyer's price while giving you a path to yours. Buyers also use earnouts to keep founders engaged after closing and to shift risk when the company depends on a product launch, a regulatory approval or a few large customers.
From the seller's side, an earnout is a bet on a business you no longer control, paid by a buyer who would rather not pay it. SRS Acquiom's deal studies have found that a large share of earnouts pay out less than their maximum, and many pay nothing. That doesn't make them worthless. It means the earnout should be the part of the price you can afford to lose.
Every earnout has five parts. The metric is what gets measured: revenue, annual recurring revenue, gross profit, EBITDA, units shipped, customers signed, or a milestone such as a product release or a regulatory approval. The targets are the numbers the metric must hit. The period is how long the measurement runs, commonly one to three years. The payout formula turns performance into dollars. The covenants say how the buyer must run the business while the clock runs.
Revenue is a common metric for software and services companies because it is hard to manipulate. EBITDA or profit is the worst for sellers, because the buyer controls costs: it can allocate overhead to your business unit, raise salaries, move spending forward or charge intercompany fees. If the buyer insists on a profit metric, define every line of the calculation and exclude allocations of the buyer's corporate costs. A milestone works well when the value really does turn on one event, provided the milestone is defined so precisely that a third party could tell whether it happened.
Example. A buyer offers $15,000,000 at closing plus up to $10,000,000 of earnout: $5,000,000 if annual recurring revenue reaches $8,000,000 at the end of year one, and $5,000,000 if it reaches $12,000,000 at the end of year two. The company has $6,000,000 of ARR at closing.
Year one closes at $7,200,000 of ARR, 90% of the target. With a cliff, the payout is $0. With a sliding scale that starts paying at 75% of the target ($6,000,000) and pays in full at 100%, the payout is $5,000,000 multiplied by ($7,200,000 minus $6,000,000) divided by ($8,000,000 minus $6,000,000), which is $3,000,000. A straight proportional scale would pay 90%, or $4,500,000, but buyers rarely agree to pay for growth that was already in the business at closing, which is why the scale usually starts at or above the closing number.
Year two closes at $12,500,000. The second $5,000,000 is paid in full. If the agreement includes a catch-up, hitting the cumulative target in year two also pays whatever was missed in year one, which here would be another $2,000,000. Without a catch-up, the year-one shortfall is gone.
So the same business, with the same results, pays $5,000,000, $8,000,000 or $10,000,000 of earnout depending on three drafting choices: cliff versus scale, where the scale starts, and whether there is a catch-up. Negotiate all three.
This is the clause that matters most, and it is the one buyers resist most. A buyer will offer to run the business "in good faith" or to use "commercially reasonable efforts" to achieve the earnout, and will add that it may run the combined business as it sees fit. A promise of good faith gives you very little, and a general commercially reasonable efforts clause, while enforceable, is only as strong as its definition and is usually paired with language letting the buyer run the business as it sees fit. Ask instead for specific commitments for the earnout period: keep the business as a separate unit with its own books; keep the sales and engineering headcount at or above closing levels; keep pricing and discounting within an agreed range; don't divert customers, leads or products to another part of the buyer; don't change revenue recognition; and don't take any action whose main purpose is to avoid or reduce the earnout. Add that if the buyer sells, shuts down or materially restructures the business, the earnout accelerates and pays at the maximum.
Delaware courts, which govern many of these agreements, enforce earnout provisions as written. They have held buyers to specific efforts commitments and have declined to add obligations the contract left out. The standard you write is the standard you get, so write a specific one.
Acceleration. The earnout should pay in full if the buyer sells the business, if it winds the business down or stops selling the product, or if a founder whose employment is tied to the earnout is terminated without cause or resigns for good reason. Without this, a buyer can end the earnout by ending the business or the founder.
Reporting. Require quarterly statements of the metric, access to the underlying books and the right to meet with the finance team. You can't dispute what you can't see.
Disputes. Send calculation disputes to an independent accounting firm whose decision is final and quick, with the loser paying. Keep legal questions, such as whether the buyer breached a covenant, for the courts. Set a deadline for the buyer to deliver its calculation and a window for you to object.
Set-off. Buyers ask to deduct indemnification claims from earnout payments. Limit set-off to claims that have been finally resolved, or to a fixed percentage, and require the rest to be paid when due.
Credit. An earnout is an unsecured promise from the buyer. If the buyer is a subsidiary or a thinly capitalized acquisition vehicle, ask for a parent guarantee. If the buyer is private and small, ask about its financing.
Who gets it. The merger agreement decides how earnout payments flow through your cap table. Earnouts paid to all holders through the liquidation waterfall are purchase price. An earnout paid only to founders who stay employed is compensation, which the buyer, the IRS and your investors will all see differently. Decide with your board and your tax advisor which structure you want before the LOI is signed.
Taxes and accounting. Earnouts raise questions about when sellers are taxed, how contingent payments are treated and how the buyer books the liability. Have a tax advisor review the structure before you agree to it.
Discount it heavily, then discount it again for a profit-based metric, a cliff, weak covenants or a buyer you don't know. A $15,000,000 cash offer is usually better than $12,000,000 cash plus a $6,000,000 earnout tied to EBITDA under a buyer's sole discretion. Model the offers side by side, assign a probability to each earnout tranche, and compare the expected values, then remember that the buyer is making the same calculation and expects to pay less than the maximum. See How Do I Read an Acquisition LOI? for how the earnout fits into the rest of the price.
For more, see Startup Acquisitions: The 3 Types of Deals and How a Sale Works, Escrow, Holdbacks and Indemnification, What Happens to My Employees in an Acquisition? and Single Trigger vs Double Trigger Acceleration.
If a buyer has proposed an earnout, contact us before you agree to the metric.
