Here’s the classic situation: the seller says, “We just signed a big contract — next year will be our best ever.” The buyer says, “I’d love to pay for that, once it happens.” An earnout is how both can be right.
How earnouts work
- Buyer and seller agree on a base price paid at or near closing.
- They agree on additional payments tied to specific future results.
- After each measurement period, results are calculated.
- If targets are hit, the buyer pays the earnout amount.
When earnouts make sense
- Valuation gaps — the seller expects growth the buyer can’t verify yet.
- Recent changes — a new product, big contract or recovery from a dip.
- Customer concentration — paying for revenue if key customers stay.
- Owner transitions — tying part of the price to relationships transferring successfully.
When they don’t
- When the seller won’t be involved and has no influence on results.
- When the buyer plans major changes that make measurement meaningless.
- When the parties don’t trust each other.
- When the targets can’t be measured cleanly.
Choosing the right metric
| Metric | Pros | Cons |
|---|---|---|
| Revenue | Simple, hard to manipulate through costs | Ignores profitability |
| Gross profit | Reflects pricing and direct costs | Requires clear cost definitions |
| Earnings or EBITDA | Ties to value | Most open to disputes over expenses and accounting |
| Customer retention | Directly addresses relationship risk | Narrow |
| Non-financial milestones | Clear for specific events | Limited use |
The terms that prevent disputes
Your attorney and CPA should help define:
- Exact metric and accounting methods. Same methods as the historical financials?
- Measurement periods and when payment is due.
- Target levels and whether payments are all-or-nothing or scaled.
- Caps and floors.
- Buyer’s operating obligations. Must the buyer run the business consistently with past practice? Can it merge, move or reprice?
- Seller’s role during the earnout.
- Information rights — the seller’s access to results.
- Acceleration — what happens if the buyer sells the business or breaches the agreement.
- Offsets for indemnification claims.
- Dispute resolution — often an independent accountant for calculation disputes.
Why earnouts fail
- Vague definitions of the metric.
- Buyer changes that reduce results — new costs, shifted customers, combined operations.
- Seller loses influence after closing and feels powerless.
- Accounting disagreements.
- Unrealistic targets set to make a headline price look bigger.
For sellers: protect yourself
- Treat earnout money as uncertain. Make sure the cash at closing is a price you can live with.
- Negotiate clear operating covenants.
- Get information rights and a dispute process.
- Consider your role — will you be able to influence results?
- Have your CPA model the tax effects.
For buyers: be fair
An earnout isn’t a way to pay less while promising more. If you use one, set achievable targets, run the business in good faith and share results transparently. Sellers talk to other sellers, and your reputation as a fair buyer matters.
Earnouts and lender rules
Lenders, including SBA lenders, have their own views on earnouts and contingent payments. Some structures may not be permitted with certain loans. Ask your lender before proposing an earnout in an LOI. See SBA loan.
Earnout vs seller note
A seller note is owed regardless of performance (subject to the documents). An earnout depends on results. Many deals use both: a note for part of the price the buyer is confident in, an earnout for the upside the seller believes in. See seller financing.
A simple test before you agree
Before signing, have both sides independently calculate the earnout from a sample year of the business’s historical financials. If you get different answers, the definitions aren’t clear enough yet. Fix them now, while everyone still agrees, rather than during the first payment dispute.
Next steps
Read financing a business acquisition and purchase agreement. If you’re weighing an offer with an earnout for a South Carolina business, start a confidential conversation.
An example in words
Picture a South Carolina service company that just won a large multi-year customer. The seller wants to be paid as if that customer’s revenue is already locked in. The buyer worries the customer could leave once the founder steps away. They agree on a base price that reflects the business without the new customer, plus an earnout paid each year the customer stays and spends at an agreed level, measured from invoices the seller can see. The seller stays involved in that relationship during transition. Both sides know exactly what triggers payment, and the seller has a real hand in earning it.
That’s an earnout working as intended: shared risk, a clear metric, aligned effort.
Questions to ask before agreeing to an earnout
- Is the cash at closing enough if the earnout pays nothing?
- Can I influence the result after closing?
- Is the metric simple enough that we’ll agree on the number?
- What stops the buyer from making changes that hurt the result?
- How and when will I see the numbers?
- What happens if the buyer sells the business during the earnout?
If you can’t answer each of these clearly, keep negotiating before you sign.
Questions people ask
What is an earnout in a business sale?
An earnout is a portion of the purchase price paid after closing only if the business achieves agreed performance targets — such as revenue, gross profit or earnings — over a defined period.
Are earnouts good for sellers?
They can be. Earnouts can help sellers get paid for growth they believe in. But they carry risk: payment depends on future results under the buyer’s control, and vague terms often lead to disputes. Clear definitions and protections are essential.