What Is an Earnout in M&A?

In the context of mergers and acquisitions (M&A), an earnout is a contractual provision that is used to defer a proportion of the purchase price based on the future performance of the acquired company. This strategy is often used in circumstances where the buyer and the seller are unable to reach an agreement on the valuation of the target company. It’s also commonly used where the future results of the target acquisition are uncertain.

While it may not be as fundamental a part of M&A as understanding what is a letter of intent, it is nonetheless a valuable strategic practice for investors and business owners alike. We’ve created this article to further explore the concept of an earnout in M&A, offering an in-depth look at how they work, what their relative advantages and risks are, and how they’re structured during global transactions. We’ve taken a global service context, rather than being limited to a single market or jurisdiction, ensuring that buyers and sellers alike gain valuable insights, whether they’re engaged in domestic M&A or complex cross-border deals. 

Definition and Purpose of Earnouts in M&A

Put simply, an earnout is a financial arrangement that forms part of an acquisition deal, in which a portion of the purchase price of a company is held back until specific future performance targets are met. This is a separate type of arrangement to upfront payment, in which the full agreed purchase price is due upon closing. Instead, acquired companies must meet pre-agreed operational or financial performance milestones to unlock the deferred amounts of payment.

In the majority of cases, the main reason for taking this approach is to bridge gaps in valuation that arise during acquisition negotiations. Often, a seller believes the company has high growth potential, while the buyer is hesitant to commit to an upfront payment without solid evidence of potential. In such circumstances, rather than exploring what is BATNA in this context, earnouts are a form of compromise. Earnouts also offer a more balanced way to manage the risks involved with unproven acquisitions alongside incentivising acquired companies to achieve peak post-acquisition performance.

Common Structures and Mechanisms

Earnouts are typically structured in one of a few ways, depending on the industry, type of business, and the perceived indicators of future success. Firstly, there’s the revenue-based earnout. This is where payments are issued only when the company has reached specific post-acquisition sales targets,

Alternatively, payments may be tied to earnings before interest, taxes, depreciation, and amortization (EBITDA) or profit metrics. Rather than considering simple top-line revenue, this approach sees the earnouts better reflecting genuine profitability.

In some instances, earnouts are based on non-financial performance milestones. This might include the successful launch of a new product or completion of regulatory approvals that put the acquired company in a position to meet value expectations.

Once the basis of the earnouts has been agreed, the parties involved will negotiate the details. This includes what specific metrics of performance trigger earnouts, the time scales these metrics must be achieved to qualify, and the schedules on which payments will be made as a result. Furthermore, many earnout agreements incorporate escrow accounts or holdback mechanisms that protect buyers in the event of disputes arising regarding performance or misreporting. These help to ensure payments are only distributed on independently verified reaching of milestones.

When Are Earnouts Used in M&A Transactions?

Earnouts are not suitable for all M&A scenarios, but there are some common situations. Firstly, they’re most often used during the acquisition of startups or companies with high growth potential. Earnouts support buyers in balancing the risks involved with uncertain short-term results.

Additionally, in acquisitions where the historical performance of a target doesn’t reflect future expectations, reaching a fair valuation can be challenging. Earnouts in these instances are ways to bridge the gap between data and expectations until performance results are proven.

Earnouts can also form part of deals where the seller intends to remain an active part of company leadership after the sale. This is because their continued involvement enables the seller to influence performance outcomes, with earnouts acting to incentivize success. 

Finally, cross-border or multi-market M&A deals often utilize earnouts. This acts as a way to better mitigate the risks involved with buyers acquiring targets in challenging regulatory environments or uncertain economic landscapes.

Advantages and Challenges of Earnouts

In the right circumstances, earnouts offer distinct advantages, including:

• Reducing risk – For buyers, earnouts can reduce the financial risk of an acquisition by making a percentage of the payment provision dependent on performance.
• Incentivizing success – The potential for additional payment once performance milestones have been achieved can incentivize sellers to enhance productivity, innovation, and other contributors to success.
• Closing deals – When there are valuation disagreements in the negotiation phase, earnouts can be an effective tool to bridge differences and close the deal in a mutually satisfactory way.

However, it’s also important to understand that earnouts can pose challenges, including:

• Post-acquisition disputes – When performance metrics are vague or open to interpretation, disputes can arise between buyers and sellers. This can affect both the efficacy of earnouts and ongoing relationships.
• Metric manipulation – In some instances, sellers may manipulate—intentionally or otherwise—performance metrics. This can trigger disputes or even contribute to value erosion.
• Elevated complexity – Earnouts are complex, particularly in cross-border scenarios. As a result, they require careful drafting by an experienced M&A consultant to avoid conflicts and commitment to ongoing monitoring of results.

Legal and Financial Considerations

The success of any earnout depends on various legal and financial factors. To begin with, the performance metrics, measurement mechanisms, and calculations for payouts must be clearly defined in the acquisition agreement. This helps to avoid potential legal and operational disputes. Setting out mutually acceptable auditing and reporting standards for buyers and sellers is key here, as they drive fair enforcement of the terms of an earnout.

Furthermore, sellers need to establish what the tax implications of deferred payments are. In cross-border situations, this can be especially important, as tax legislation varies between jurisdictions.

Governance rights, particularly the details of the seller’s involvement during the earnout period, also need to be addressed. Establishing clear roles and boundaries during the negotiation phase helps to strike a balance between giving sellers operational involvement and preserving the buyer’s control of the acquisition.

Drafting and Negotiating an Earnout Clause

Careful attention to detail is required to ensure that drafted earnout clauses are enforceable following a deal. Recommended best practices to achieve this begin with prioritizing clarity in defining the metrics and timelines upon which earnouts will be based. There must be no ambiguity about how performance is measured and when the milestones occur. The reporting methods, formats, and schedules should also be clearly outlined in drafts. Importantly, agreements need to include mechanisms for resolving disputes so that both sides know how to take action when needed.

These types of contracts can be complex, particularly in global deals. This makes professional financial and regulatory advisors vital collaborators in success. Experienced professionals understand the potential pitfalls and legal requirements and can help ensure deals are as robust as possible.

FAQs

What is an earnout in M&A?

An earnout is a deferred portion of the purchase price in an M&A deal. It is contingent on the target company meeting predetermined post-closing performance goals.

How long does an earnout period typically last?

The typical earnout period spans between 1 and 3 years. However, it can be shorter or longer depending on the deal structure and risk factors.

Can sellers influence the outcome of an earnout?

Yes, particularly when the seller continues to manage the company, which may impact results related to the earnout.

What are the risks for sellers in an earnout structure?

There’s a risk of non-payment if performance targets aren’t met or if buyers restructure operations in ways that impact outcomes.

Are earnouts enforceable in every jurisdiction?

No, as legal enforceability and contract law varies between jurisdictions, making expert counsel essential.

References

Roncagliolo, E. (2020, September). The Impact of Earnouts in M&A Agreement: An Overview of

Empirical Findings. Journal of Modern Accounting and Auditing. https://www.researchgate.net/publication/347633286_The_Impact_of_Earnouts_in_MA_Agreement_An_Overview_of_Empirical_Findings 

Hayes, A. (2024, September 6). EBITDA: Definition, Calculation Formulas, History, and Criticisms. Investopedia. https://www.investopedia.com/terms/e/ebitda.asp 

Dario de Martino, F, et al. (2025, July 11). The Art and Science of Earn-Outs in M&A. https://corpgov.law.harvard.edu/2025/07/11/the-art-and-science-of-earn-outs-in-ma/