M&A & Due Diligence
What Is an Earnout (M&A)?
An earnout is contingent purchase price paid to the seller after close based on hitting agreed performance targets, typically 10 to 40 percent of total deal value tied to revenue, EBITDA, or unit goals over 1 to 3 years. Buyers use them to bridge valuation gaps and reduce upfront cash, but the seller no longer controls operations. Sellers regularly forfeit 30 to 70 percent of an expected earnout by agreeing to EBITDA targets without locking in cost-allocation rules.
An Earnout is contingent purchase price — payable post-close to the seller based on hitting agreed performance targets. Common in M&A when there's a valuation gap, buyer wants to reduce upfront cash, or seller wants to capture more upside. Also where deals quietly go wrong.
Typical structure
- Metric: revenue, EBITDA, unit volume, or operational KPI
- Period: 1–3 years post-close
- Target levels: often tiered (base → target → max payout)
- Payout schedule: annual installments or single payment at end of period
- % of deal value: usually 10–40% of total purchase price
Example
Deal value: $20M total. Upfront: $14M cash. Earnout: $6M over 2 years, tied to hitting $30M revenue Year 1 and $36M Year 2. If targets hit: full $6M earnout paid. If revenue lands at $28M / $34M: partial earnout, perhaps $4M. Below threshold: zero earnout. Total deal value swings from $14M to $20M based on post-close execution the seller no longer controls.
Seller protections to negotiate
- Operating standard: buyer must operate brand in good faith, can't starve it
- Resource commitments: marketing budget, headcount, capex floor
- Cost allocation: if buyer pushes brand onto shared services, those allocations can't crush earnout EBITDA
- Books and records: seller gets access to records to verify earnout calculation
- Dispute resolution: independent accountant if parties disagree
The most common mistake
Agreeing to an EBITDA-based earnout without locking in cost allocation rules. The buyer adds shared-services allocations, parent-company corporate costs, and reduces marketing budget — earnout EBITDA collapses without operating performance actually changing. Sellers regularly forfeit 30-70% of expected earnout on this issue alone.
Frequently Asked Questions
Why do buyers use earnouts?
Bridge valuation gap, reduce upfront cash, keep seller motivated.
What's in an earnout structure?
Metric, period, targets, payout schedule, operational protections.
How do sellers protect themselves?
Operating standard, resource commitments, cost-allocation rules, books access, dispute resolution.
Related Terms
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Negotiating an earnout? Talk to a CFO first.