How Earnouts Actually Work in Mergers & Acquisitions

Earnouts can solve this disconnect. They let both sides move forward without forcing a hard price compromise. But for them to work, the terms have to be grounded in reality, tied to clear, measurable goals, and structured with aligned incentives.

Earnouts are deal terms that link part of the purchase price to future performance. Instead of paying everything up front, the buyer agrees to additional payouts if the company hits specific targets after the transaction.

These targets vary, but the goal is the same: reduce risk for the buyer while giving the seller a path to full value. Earnouts are common in founder-led deals where the business still has room to grow or stabilize.

Earnouts are usually layered into the purchase agreement after a baseline valuation is agreed on. They don’t replace cash at close but defer a portion of the total price, making it conditional on future results. This structure helps buyers reduce risk and gives sellers a chance to capture more value.

For founder-led companies, especially in fintech, payments, SaaS, or AI, earnouts often come into play when there’s still upside to prove. They’re also used when a founder plans to stay involved after the transaction, allowing the buyer to tie future payouts to continued performance.

Most earnouts last between one and three years. Shorter timelines are easier to manage and tend to result in fewer disputes. Longer earnouts can increase potential value but often come with more complexity and execution risk.

Payment terms are usually structured in annual installments, triggered once performance targets are verified. Some deals include a cap on total payout, while others offer tiered rewards based on how far targets are exceeded. Timing, clarity, and payout mechanics should all be locked down in the final agreement.

Earnouts rely on specific, measurable performance goals to determine payouts. Common metrics include revenue, gross profit, and net income. These figures offer a clean view of how the business is performing after the deal and are less likely to spark conflict when calculated properly.

In more specialized sectors, different benchmarks apply. SaaS companies may focus on annual recurring revenue or churn. Payments and fintech deals might use transaction volume or take rate. The right metric should reflect the business’s core value drivers and be easy to verify based on standard reporting.

Founders often rely on earnouts to capture additional value beyond the upfront payment. When tied to achievable goals, these structures can reward continued involvement and strong post-close performance. But if the terms are unclear or based on factors outside their control, it can create frustration and missed expectations.

From an investor’s perspective, earnouts help justify a higher valuation without taking on all the risk at close. They create a buffer and ensure that future payouts reflect actual results. When both sides agree on fair terms, earnouts can help close the gap and move the deal forward.

Earnouts are typically defined in the purchase agreement as contingent payments based on future results. The structure outlines the payout schedule, performance metrics, time frame, and any caps or thresholds.

A strong structure is specific, transparent, and tailored to the company’s model. Both sides need a shared understanding of how results will be measured and how payments will be calculated.

Revenue-based earnouts use top-line performance as the trigger for payment. Buyers favor this approach when the business is expected to scale quickly, and sellers benefit when they maintain influence over sales outcomes. Clarity around what counts toward revenue is key to avoiding disputes.

Milestone-based triggers depend on achieving defined goals, such as completing a product rollout, entering a new market, or securing a strategic partnership. When tied to meaningful progress, milestones can provide flexibility while still aligning incentives between both sides.

Founders should push for terms that reflect what they can realistically control after the deal closes. That means defining performance metrics clearly, agreeing on how results will be tracked, and avoiding language that leaves room for interpretation.

It’s also important to lock in timelines, payment schedules, and dispute resolution terms. Buyers may try to widen the scope of control or reserve rights that could affect performance. A well-negotiated earnout protects against changes that could reduce or delay payout.

Ambiguous language around performance metrics, timing, or payout conditions opens the door to future disputes.

Operational changes, new systems, or shifting priorities can all impact performance. Founders should understand how the buyer plans to run the business post-close.