An earnout is a way to bridge the gap when a buyer and seller disagree on what a business is worth. The seller gets part of the price upfront and part later, but only if the business hits agreed-upon targets after closing. Earnouts are common in Main Street deals, and they are also where sellers lose the most money they thought they had already earned. Understanding how they work before you negotiate one is not optional.

What an earnout is

In a typical sale, the buyer pays a fixed price at closing. In a deal with an earnout, part of that price is deferred and tied to future performance. If the business hits the targets, the seller receives the earnout payment. If it does not, the seller does not.

Earnouts usually appear when the buyer is uncertain about future earnings. Maybe revenue has been volatile. Maybe a large contract is up for renewal. Maybe the seller claims next year will be the best year yet, and the buyer wants proof before paying for it. The earnout lets both parties move forward without either one having to fully concede on price.

How earnouts are typically structured

Every earnout is different, but most Main Street earnouts follow one of a few patterns.

Revenue-based earnout

The seller receives additional payment if revenue exceeds a threshold during a defined period, usually one to two years after closing. Example: $200,000 earnout if revenue exceeds $1.5 million in year one. Simple to measure, but revenue can be manipulated by pricing decisions the buyer controls after closing.

Profit-based earnout

Payment tied to SDE, EBITDA, or net profit hitting a target. Harder to game than revenue, but the buyer controls spending after closing. A buyer who loads the business with overhead can miss a profit target that would have been easy under the seller's management.

Milestone-based earnout

Payment triggered by specific events: a key contract renewed, a new license obtained, a product launched, or a geographic expansion completed. These are the cleanest earnouts because the outcome is binary and less subject to accounting manipulation.

Retention earnout

Payment tied to customer or employee retention after closing. Common when a few large customers or key employees are critical to the business. Example: $100,000 if the top three customers remain through year one.

Why sellers should be cautious

Earnouts sound fair in theory. In practice, sellers collect less than expected more often than not. Here is why.

  • You no longer control the business. After closing, the buyer makes pricing, hiring, marketing, and spending decisions. Those decisions directly affect whether earnout targets are met.
  • The metrics can be gamed. A buyer who wants to avoid an earnout payment can shift expenses, delay revenue recognition, or make capital investments that reduce short-term profit.
  • Disputes are expensive. When the seller thinks the target was met and the buyer disagrees, resolution requires accountants, attorneys, and time. Most sellers lack the leverage to fight after closing.
  • Earnouts delay your exit. You may need to stay involved, provide information, and monitor performance for one to three years after you thought you were done.
  • Tax treatment can be unfavorable. Earnout payments may be taxed as ordinary income rather than capital gains, depending on structure. Your CPA should model this before you agree.

How to negotiate a fair earnout

If an earnout is necessary to close the deal, negotiate the terms as carefully as you negotiate the price.

  1. Keep the earnout portion small. Aim for no more than 15 to 20 percent of the total deal value in the earnout. The majority of your money should be cash or a seller note at closing.
  2. Use simple, objective metrics. Revenue above a fixed dollar amount is easier to verify than "adjusted EBITDA excluding extraordinary items." Simplicity protects you.
  3. Define the measurement period clearly. One year is better than three. Shorter periods mean less time for the buyer to influence results.
  4. Include a floor payment. Negotiate partial payment if the business performs reasonably but falls slightly short. All-or-nothing earnouts heavily favor the buyer.
  5. Limit the buyer's ability to change the business. Include covenants that prevent the buyer from making major changes (closing locations, firing key staff, changing pricing) during the earnout period without your consent.
  6. Specify dispute resolution. Agree upfront on an independent CPA to resolve measurement disputes, with the cost split evenly.

An earnout is not a bonus. It is part of your price that you only collect if someone else runs your business the way you would have. Plan accordingly.

A warning experienced brokers give every seller

When an earnout makes sense for the seller

Earnouts are not always bad. They can work in your favor when:

  • You genuinely believe earnings will grow and want to capture that upside.
  • A specific, verifiable milestone (contract renewal, license approval) is pending and likely to close.
  • The earnout is a small portion of the deal and the upfront payment meets your needs.
  • You will remain involved post-closing in a defined role and can influence the outcome.
  • The alternative is no deal at all, and the earnout is the only way to bridge a reasonable gap.

When to refuse an earnout

Push back hard, or walk away, when:

  • The buyer wants more than 25 percent of the price in an earnout with vague metrics.
  • The earnout period exceeds two years.
  • The buyer will not agree to operational covenants during the earnout period.
  • You need the full proceeds at closing for retirement, debt payoff, or your next venture.
  • The buyer's proposed metrics are complex enough that you cannot calculate them yourself.

The best protection against a bad earnout is a strong upfront price backed by a defensible valuation. When the buyer trusts your numbers and believes in the business, the earnout disappears from the conversation.