When you sell your business, you expect to receive a price that reflects the value of what you have built. But in many transactions, the buyer and seller do not see eye to eye on exactly what that value is. One of the most common tools used to bridge that gap is an earnout, a deal structure where a portion of the purchase price is paid over time based on the business's future performance.

Earnouts can be useful in the right circumstances, but they also carry real risks for sellers. Before agreeing to an earnout, it is important to understand how they work, what can go wrong, and what alternatives might serve you better.

What Is an Earnout?

An earnout is a contractual provision in which the seller receives additional payment after closing if the business meets certain performance targets during a defined period. The targets are typically tied to financial metrics such as revenue, gross profit, or EBITDA, though they can also be based on milestones like customer retention, product launches, or contract renewals.

For example, a buyer might offer $4 million at closing plus an additional $1 million if the business achieves $3 million in revenue over the following 12 months. The total deal value is $5 million, but $1 million of that is contingent on future results.

Why Buyers Propose Earnouts

Buyers use earnouts for several legitimate reasons.

  • Bridging a valuation gap. The seller believes the business is worth $6 million based on its trajectory. The buyer sees $4.5 million based on current financials. An earnout lets both parties move forward by making part of the price contingent on the growth actually materializing.
  • Aligning incentives. When the seller stays involved during a transition period, an earnout gives them a financial reason to remain engaged and help the business succeed under new ownership.
  • Reducing risk. If the business has a concentration of revenue in a few key customers, or if there is uncertainty about a pending contract renewal, an earnout shifts some of that risk from the buyer to the seller.

Common Earnout Structures

Earnouts vary widely in their design, but most fall into a few categories.

Revenue-Based Earnouts

The earnout is paid if the business hits a specific revenue target. Revenue is relatively easy to measure and harder to manipulate, which makes this structure more straightforward for both parties. However, it does not account for profitability, so a buyer could grow revenue at the expense of margins.

EBITDA-Based Earnouts

The earnout is tied to earnings before interest, taxes, depreciation, and amortization. EBITDA-based earnouts more closely reflect the health of the business, but they are also more susceptible to accounting decisions. The buyer controls expenses after closing, and changes in how costs are allocated can significantly affect EBITDA.

Milestone-Based Earnouts

Rather than a financial metric, the earnout is triggered by achieving specific milestones: renewing a key contract, completing a product development project, retaining a certain number of customers, or hitting an operational target. These can work well when the valuation gap is driven by uncertainty about a specific outcome.

The Risks for Sellers

On paper, earnouts sound reasonable. In practice, they are a frequent source of conflict in business sales. Here are the risks sellers should understand.

  • Loss of control. After closing, the buyer controls the business. They make decisions about pricing, staffing, marketing, capital expenditures, and strategy. If those decisions negatively affect the metrics your earnout is tied to, your payout suffers even though you had no say in those decisions.
  • Accounting manipulation. With EBITDA-based earnouts, a buyer can allocate corporate overhead, management fees, or other costs to the acquired business, reducing earnings and the earnout payment. Even without bad faith, differences in accounting practices can create genuine disagreements.
  • Changed strategy. A buyer may shift the business's direction in ways that prioritize long-term growth over short-term financial targets. That might be good for the business but bad for your earnout.
  • Disputes and litigation. Earnout disputes are among the most common sources of post-closing litigation in business acquisitions. The costs and stress of resolving these disputes can erode whatever value the earnout was supposed to provide.

Protecting Yourself If You Accept an Earnout

If an earnout is part of your deal, there are steps you can take to reduce the risk.

  • Use clear, objective definitions. Every metric in the earnout should be precisely defined using agreed-upon accounting methods. Ambiguity is the enemy.
  • Include operational guardrails. Negotiate provisions that prevent the buyer from making decisions specifically designed to reduce your earnout. For example, require that the business be operated in the ordinary course, or that the buyer cannot allocate corporate overhead to the acquired entity.
  • Set up a dispute resolution mechanism. Include a clear process for resolving disagreements, whether through an independent accountant, mediation, or arbitration. This avoids the cost and delay of full-blown litigation.
  • Keep the earnout period short. The longer the earnout period, the more things can change. Twelve to eighteen months is more manageable than three to five years.
  • Retain some operational influence. If your earnout depends on business performance, negotiate the ability to remain involved in key decisions during the earnout period, whether in an advisory role or through a consulting agreement.

Alternatives to Earnouts

Earnouts are not the only way to structure a deal when there is a valuation gap or when the buyer wants to reduce risk. Consider these alternatives.

Seller Note

A seller note is a loan from the seller to the buyer, typically for a portion of the purchase price. Unlike an earnout, the payment is fixed and does not depend on business performance. The seller receives regular payments with interest over a defined period. This provides certainty for the seller while still allowing the buyer to pay over time.

Consulting Agreement

Instead of tying additional compensation to business performance, the buyer pays the seller for a defined period of consulting services during the transition. This gives the seller additional income, keeps them involved during the critical handoff, and avoids the complexity and risk of an earnout.

Equity Rollover

In some transactions, the seller retains a minority ownership stake in the business. This aligns the seller's interests with the buyer's long-term success without the specific pitfalls of an earnout structure. Equity rollovers are more common in private equity transactions but can work in other deal types as well.

Choosing the Right Structure

The best deal structure is one where both parties feel the terms are fair and the risks are appropriately shared. If a buyer insists on an earnout, it is worth asking why. If the answer is that they are not confident in the business's projections, that is a conversation worth having openly. Sometimes the solution is not an earnout but a more realistic valuation based on current performance.

At Hawkfall Holdings, we believe in straightforward deal structures. We value businesses based on what they are today, not on speculative future performance. While every transaction is different, our goal is to present offers that are clear, fair, and easy to understand.

If you are considering selling your business and want to understand what a fair deal might look like, we invite you to visit our Sell Your Business page or start a confidential conversation. We are happy to walk through the process and answer your questions with no obligation.