An earnout is a contractual provision where a portion of the business purchase price is deferred and paid only if the business achieves specific performance milestones after closing. Earnouts bridge valuation gaps — sellers who believe the business will continue growing accept some deferred risk; buyers who are uncertain about post-close performance pay less upfront while retaining the ability to pay more if results materialize.
Common Earnout Structures
Earnouts are typically measured over 1–3 years post-closing on metrics such as: annual revenue (exceeding a threshold), gross profit, EBITDA, or specific operational metrics (client retention rate, contract renewals). For example: 'Seller receives $200,000 per year for 2 years if annual revenue exceeds $2M in each year.' Payment schedules can be annual or quarterly.
Negotiating Earnout Terms
Sellers should negotiate: control over the operational and financial decisions that drive the earnout metric, clear accounting definitions for how the metric is calculated, audit rights to review post-close financials, and acceleration provisions if the buyer materially changes the business strategy. Buyers who gain full operational control post-close and then manage the business in ways that reduce earnout payments have created one of the most common post-acquisition disputes in small business transactions.
When earnouts are appropriately structured with protective provisions for the seller, they can represent fair additional consideration for a business sale. When they are loosely defined and buyer-controlled, they represent deferred consideration the seller may never receive.