An earnout is a deal mechanism in which part of the purchase price is deferred and made contingent on the target achieving agreed performance targets after closing. It is used to bridge a valuation gap when the buyer and seller disagree about the business's prospects.
How it works
At closing the seller receives an up-front amount; additional payments follow over an earnout period (commonly one to three years) if the business hits specified metrics, such as:
- Revenue or EBITDA thresholds,
- unit or customer milestones, or
- project- and product-specific goals (common where success is uncertain, e.g. early-stage or life-sciences targets).
Why use one
- Bridges disagreement about value — the seller "earns out" the higher price by delivering the results they project.
- Retains and motivates founders or management who stay on.
- Shares risk between the parties.
Risks and disputes
Earnouts are a frequent source of post-closing litigation. Common friction points:
- Measurement — how the metric is defined and calculated (accounting choices can swing it).
- Control — after closing the buyer runs the business and its decisions (investment, integration, allocation of costs) can affect whether targets are met; sellers often negotiate covenants to protect the earnout.
- Alignment — short earnout targets can distort behaviour.
Accounting
Under ASC 805 (US GAAP) and IFRS 3, an earnout is contingent consideration measured at fair value at the acquisition date and included in the consideration transferred (affecting goodwill); subsequent changes in fair value are generally remeasured through earnings.
See also
- Deal structure — How an acquisition is assembled — chiefly the choice between buying stock or assets.
- Definitive purchase agreement — The binding contract that governs an acquisition and its terms.
- Goodwill — The intangible asset recorded when a buyer pays more than the fair value of net assets.
- Business valuation — The set of methods used to estimate the economic value of a company or its equity.