When selling your company, the ideal outcome is simple: a good valuation, paid in cash on completion. In reality, however, many transactions are more complex than this. This is especially true in deals involving fast growing tech companies where sellers want to capture the value of the future opportunity, and buyers may be more cautious in what they are prepared to pay for based on where the business is today. A common means of bridging this gap is to use an earnout.

Earnouts can help close deals and increase headline valuations. But they also introduce risk, complexity and potential misalignment.

This article explains what earnouts are, how they work in practice, and most importantly, discusses when sellers should (and should not) accept them.

What Is an Earnout?

An earnout is a deal structure in which a portion of the purchase price is deferred and paid only if the business achieves certain milestones after completion. In other words you receive part of the consideration on close and the rest is earned (and paid) over time, based on performance.

The earnout mechanism is agreed at the time of the deal and will typically be contingent payments linked to pre-agreed future outcomes over a defined measurement period. These periods can be quite short (6-12 months) or longer (up to several years).  The metrics are generally financial, such as revenues or ARR (either a threshold or a growth hurdle) or profitability (EBITDA). It may sometimes be related to delivery of product or technology milestones, or other measurable outcomes such as retention of customers.

Why Are Earnouts Used?

Simply put: an earnout allows the buyer to increase the headline valuation of the deal, but reduce its upfront risk by making full payment dependent on delivery against future agreed targets.

Earnouts exist for one primary reason: when buyers and sellers disagree on value. An earnout allows both sides to proceed by effectively saying:

“If the business performs as projected, the seller receives the full value. If not, the buyer pays less.”

This makes earnouts a bridge between expectation and reality, particularly in:

• High-growth or early-stage businesses
• Situations with limited historic financial visibility
• Businesses undergoing change (new products, markets, or leadership)

Typically, earnouts represent 10–25% of total consideration in mid-market deals, although they can be higher in growth sectors where the risk of future performance is higher.

The Advantages of Earnouts

1. Bridging valuation gaps

Earnouts are often the key mechanism to get a deal done when there is a gap in price expectations.

2. Potential for higher total value

If performance is achieved, sellers may receive a higher overall price than available at completion.

3. Alignment of incentives

Both buyer and seller are incentivised to drive post-deal performance, assuming the seller is still involved. If the seller is not involved, then you need to make sure that the person who is tasked with delivery has a strong enough incentive to achieve it.

4. Getting a deal done in uncertain markets

Earnouts are particularly useful in volatile or high-growth sectors, where forecasting is difficult.

The Risks of Earnouts (From a Seller Perspective)

1. You may never receive the money

By definition earnouts are not guaranteed. If your targets are too aggressive and you miss them,  the earnout may be worth zero. This makes the choice of the earnout metric critical, and it should be very carefully negotiated and clearly measurable. Structure is also really important. Is the metric all or nothing above a threshold, or is there a structure that allows for a sliding scale of outcomes so you get at least something?  Is there a single lump sum, or are the payments staged? These issues can make a material difference to the likelihood of the earnout being received.

2. Loss of control post-sale

After completion, the buyer typically controls the company, its strategy and decisions around investment in resources. This can directly impact whether targets are achieved and is often outside the seller’s control. Protections that can be enforced and provide for you to have access to the resources you need to achieve the earnout targets should be negotiated into the deal documentation.

3. Risk of disputes

Earnouts can be a sources of post-deal conflict, if not properly negotiated and defined. This might arise from ambiguity in metrics or accounting treatment, or decisions that have been taken post deal that affect performance (eg a change in strategy driven by the buyer which means a change in direction for the company).

4. Misalignment of incentives

Poorly structured earnouts can create tension, especially where sellers focus on optimising short-term results in order to deliver on the earnout, vs buyer desire to focus on long-term integration. It also depends on the post transaction strategy. If the two companies are to be fully integrated post transaction, earnouts can be very difficult to structure, whereas if they are kept as separate entities they will tend to be more objectively measurable.

Should You Accept an Earnout?

There is no right or wrong answer to the question of whether you should accept an earnout. Properly designed, they are a pragmatic tool to bridge valuation gaps and share risk. Done badly they can erode value, delay proceeds, and create disputes.

As a core deal principle you should still aim for the maximum possible cash at close, as this is objectively the value you can rely on. However, if you can unlock a significantly better deal on the basis of realistic, clearly defined and measurable targets that you have a high degree of control over achieving, then an earnout can make sense. In contrast, if the earnout depends on factors outside your control (eg market conditions, buyer integration), are subjective or overly ambitious, or are excessively long, then you should be very cautious about accepting one.

Ultimately an earnout is a mechanism for allocating risk between the buyer and the seller, and like any risk, it should only be accepted when it is understood, appropriately priced and properly managed.

We help clients negotiate these and other issues as part of our SMART dealmaking process, in order to maximise their outcome in a sale. Get in touch and let’s talk.