Earnout

Why Earnouts Get Used

The core use case: a business is growing fast and the seller wants credit for future performance; the buyer wants to pay for what's been proven. An earnout bridges this gap by making part of the purchase price contingent on the business actually achieving what the seller projects.

They also appear when:

• A business has high customer concentration or key-person risk that makes the buyer nervous
• Revenue quality is uncertain — a new contract signed but not yet generating cash
• A distressed business is being sold with upside potential but current losses

How Earnouts Are Structured

A typical earnout specifies:

• Metric: Revenue, gross profit, EBITDA, or number of customers — revenue is the most common because it's harder to manipulate than profit
• Target: The level the business must reach to trigger the payment
• Period: Usually 12-36 months post-close
• Payment structure: A single payment at the end, annual installments, or a sliding scale

The Post-Close Conflict Problem

Earnouts are litigation-prone because the buyer now controls the business and the accounting. Classic disputes:

• Expense manipulation: Buyer loads expenses into the earnout period, suppressing the profit metric the earnout is measured against
• Strategic decisions: Buyer makes long-term investments that hurt near-term revenue, arguing they're necessary for the business — seller argues they were timed to tank the earnout
• Definitional disputes: What counts as "revenue" when the contract uses "net revenue," "recognized revenue," or "booked revenue" — all different numbers

When Earnouts Work

Earnouts work best when:

• The metric is revenue, not profit (harder for buyer to manipulate)
• The period is short (12-18 months)
• The buyer is passive or operator-light (less opportunity to influence the metric)
• The contract specifies exactly what the buyer can and cannot do during the earnout period