What Is Earnout?Definition and Examples

Earnouts are most commonly used when the buyer and seller cannot agree on a purchase price because they have different expectations about future performance. If a seller believes the business will grow 20% per year and wants a price reflecting that growth, but the buyer sees 10% growth as more realistic, an earnout lets them split the difference: the buyer pays a base price reflecting conservative assumptions and additional payments if the optimistic scenario materializes. This mechanism converts a price disagreement into a shared bet on future results.

In practice, earnout structures require careful legal drafting to prevent disputes. The purchase agreement should specify exactly how the metrics are calculated, who prepares the financial statements, what accounting methods are used, whether the buyer can make operational changes that affect the metrics, and what dispute resolution mechanisms are available. Poorly drafted earnouts generate lawsuits; well-drafted earnouts align incentives and facilitate fair outcomes for both parties.

Sellers should approach earnouts with realistic expectations. Industry data suggests that approximately 50-60% of earnout payments are eventually made in full, with the remainder either partially paid or not paid at all. To protect themselves, sellers should negotiate for earnout metrics they can influence (revenue rather than EBITDA), insist on operational covenants that prevent the buyer from undermining the business, and structure the base price at closing to represent a satisfactory outcome even if the earnout is never paid.