Earnout (often written as one word) is the M&A mechanism where part of the purchase price depends on the acquired company’s future performance under new ownership.

How it works

Purchase agreements specify an earnout schedule: metrics (revenue, gross profit, user counts, regulatory milestones), measurement periods, payment caps, and set-off rights if sellers breach representations.

A venture-backed SaaS company sells for $60M: $45M cash at close, $15M earnout if net revenue retention stays above 110% for two fiscal years. Payment may be annual or lump-sum at end.

Earnouts differ from escrow holdbacks (reserved for indemnity claims) and from seller notes (deferred fixed payments). Earnouts are variable and performance-linked.

Legal teams track earnout receivables on balance sheets; disputes often land in arbitration over accounting policy changes post-acquisition.

Why it matters

• Founders: Read who runs the business during the earnout window. Integration decisions by the buyer can help or hurt your metric. Seek carve-outs for force majeure and buyer-caused changes.
• Investors: Diligence earnout probability in exit models. Preferred liquidation may absorb fixed cash first, leaving earnout upside to common if structured poorly.
• Counsel: Consistency in definitions (GAAP vs management metrics) prevents eight-figure disagreements.

Common mistake

Banking the maximum earnout in personal financial plans. Industry experience shows a meaningful share of earnouts pay below maximum due to metric disputes, integration issues, or buyer strategy shifts.

Related ideas

• Earn-Out — hyphenated form, same concept
• Escrow — separate holdback pool
• Purchase price adjustment — working capital true-ups
• Drag-Along Rights — forces all sellers into same deal terms