Earnouts: when they bridge the gap, and when they cost you

An earnout is what happens when a buyer and a seller cannot agree on what a business is worth. You believe next year looks like the plan. The buyer believes it looks like last year. Rather than split the difference, you agree the extra money gets paid if the plan turns out to be right.

It sounds reasonable to everyone in the room. The problem is that you will be measuring a business you no longer control, using numbers the buyer produces.

Why they fail

The metric is one the buyer controls

EBITDA-based earnouts are the most common and the most dangerous. Post-close, the buyer decides what gets charged to your business: management fees, allocated overhead, a share of corporate insurance, their own systems and staff. None of it is bad faith. All of it reduces the number your payment depends on.

The period is too long

Three years after closing, your business has been merged into something else. Customers have been re-papered, staff has moved, the reporting entity barely resembles what you sold. Attributing performance to your former company becomes a matter of opinion, and opinion is not a payment mechanism.

Nothing obligates them to try

Without covenants, a buyer has no contractual duty to run the business in a way that maximizes your earnout. If they decide to pause a product line, shift a territory, or hold price, that is their right as the owner. It is also the end of your payment.

If the deal only works for you because the earnout pays in full, it is not a deal that works for you.

What makes them work

• Measure revenue, not profit. Revenue is harder to manipulate and far easier to verify. You give up some upside for a number you can actually collect on.
• Keep it short. Twelve to twenty-four months. Long enough to prove the point, short enough that the business is still identifiable.
• Use one metric. Every additional condition is another place the calculation can go sideways.
• Write the operating covenants. Maintain the sales force, keep the pricing structure, do not reallocate accounts out of the measured entity, no new corporate charges against it. Specific commitments, not a general good-faith clause.
• Get audit rights and a schedule. Quarterly statements showing the calculation, plus the right to inspect the underlying records. Silence for a year is how disputes start.
• Add acceleration. If the business is sold again, if you are terminated without cause, or if the buyer materially changes the operation, the remaining earnout becomes due.
• Stay close to the levers, or price it lower. If you are staying on with real authority over the thing being measured, an earnout is reasonable. If you are leaving at closing, insist on more cash and less contingency.

The honest version

A well-structured earnout closes deals that would otherwise die, and plenty of sellers collect in full. But the seller who does well is almost always the one who negotiated the mechanics as carefully as the headline number, and who could have lived with the deal if the earnout paid nothing at all.