Earnouts let buyers pay more — but only if future performance hits targets. Here's when to accept an earnout and when to push back.
Jason Taken
HedgeStone Business Advisors
An earnout is a provision in a business sale where a portion of the purchase price is contingent on the business hitting future performance targets. Buyers use earnouts to bridge price gaps when they believe the seller's revenue claims are optimistic. Sellers accept earnouts hoping to get paid the full value. The reality: most earnouts underperform seller expectations.
A typical earnout: $2M cash at close + up to $500K earnout if the business achieves $1.5M revenue in year 1 post-close. The earnout is paid on a sliding scale or as a binary trigger. The challenge: once you've closed, you're no longer in control. The buyer manages the business. They control hiring, pricing, and sales strategy. If year-1 revenue misses the target due to decisions you had no input on, you don't get paid.
Earnouts make sense for sellers when: you're staying in the business post-close (management role for 2–3 years), the earnout metrics are completely within your control, the earnout period is short (12 months max), the earnout represents a small percentage of total price (under 15%), and the metrics are simple and unambiguous (revenue, not EBITDA, which can be manipulated by the buyer's cost allocations).
Common earnout structures sellers regret: EBITDA-based metrics (buyer can allocate overhead to your division, crushing EBITDA). Multi-year earnouts (you're tied to the business for 3 years hoping the buyer manages it well). Earnouts with no audit rights (you can't verify the numbers). Earnouts that require YOU to work for the buyer to receive payment (structurally turns the earnout into compensation, not sale proceeds). High earnout percentages (if 40% of the price is earnout, you've only sold 60% of your business at closing).
If you must accept an earnout: use revenue as the metric (not EBITDA), demand monthly reporting with audit rights, cap the earnout period at 12 months, include acceleration clauses (if you're acquired by another company during the earnout period, you receive the full earnout immediately), and require the buyer to continue operating the business in substantially the same way during the earnout period.
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