What is earnout?

For buyers and founders looking to sell, understanding earnouts is critical because they bridge valuation gaps and incentivize seller cooperation post-acquisition. Buyers often propose earnouts when there's uncertainty about future performance, or when a significant portion of the business value is tied to intangible assets or the seller's continued involvement. For sellers, an earnout can mean a higher total payout, but it also ties a significant part of their proceeds to future performance metrics, effectively keeping them 'in the game' longer.

Earnouts are typically structured around clear, measurable targets like revenue, EBITDA, SDE, or customer retention over a specified period, often 1-3 years. The key is to define these metrics precisely within the asset purchase agreement or stock purchase agreement to avoid disputes. A common misconception is that an earnout guarantees a higher sale price; rather, it often shifts risk from the buyer to the seller, and poor post-acquisition performance can result in a smaller-than-anticipated final payout. Buyers must also consider how their operational changes might impact the seller's ability to hit earnout targets, which can lead to friction.

The 2026 market sees earnouts as increasingly common for main street and lower-middle market deals, especially for businesses with strong growth trajectories or those heavily reliant on the founder's personal sales and relationships. For founders validating startup ideas, an earnout structure can sometimes be an attractive exit path if their growth projections are ambitious but not yet fully realized. It allows them to demonstrate future value rather than selling purely on historical SDE or EBITDA multiples where their growth might not be fully reflected. Due diligence is essential to identify if an earnout is suitable, and robust legal documentation is paramount for both parties to protect their interests.