One of the most fascinating tools I’ve used in acquisitions is the earnout. When I first heard about earnouts, I thought they were just a way for buyers to avoid paying too much upfront. Over time, I’ve learned they’re far more than that. Done correctly, an earnout isn’t just a financial mechanism; it’s a way to align the goals of buyer and seller during a fragile transition.
Earnouts can be complex, but they’ve saved deals, created fairness in negotiations, and given both sides confidence when uncertainty exists. In this article, I’ll break down how I think about structuring earnouts, the mistakes I’ve made, and the principles I follow to make them work for everyone involved.
What an Earnout Really Is
At its core, an earnout is a portion of the purchase price that’s paid to the seller later, based on the business hitting certain targets. Instead of paying everything at closing, I pay part upfront and part over time if agreed-upon milestones are met.
This structure is especially useful when:
- The business has growth potential but also risk.
- The seller believes strongly in future performance.
- The buyer (me) wants protection if projections don’t come true.
Earnouts create a bridge between differing views of value.
Why Earnouts Align Interests
I like earnouts because they align incentives. The seller doesn’t just walk away with a check they have skin in the game. They’re motivated to support me during the transition, help retain customers, and ensure employees are engaged.
For me, as the buyer, earnouts provide protection. If revenue or profit declines after closing, I’m not overpaying for performance that never materializes.
When structured correctly, earnouts make both sides partners in success.
My Principles for Structuring Earnouts
Over time, I’ve developed principles that guide how I set up earnouts:
1. Keep the Metrics Simple
I’ve seen earnouts fail when they’re tied to complicated formulas. Sellers get frustrated if they don’t understand how payments are calculated. I tie earnouts to simple, clear metrics like revenue, gross profit, or EBITDA.
2. Define the Timeframe Clearly
Most earnouts I structure last 1–3 years. Any longer, and the seller starts to feel disconnected. Any shorter, and there isn’t enough time to measure true performance.
3. Align With Seller’s Influence
If the seller stays involved during the transition, I tie the earnout to performance metrics they can influence. If they’re stepping away, I avoid metrics that they have no control over it only breeds resentment.
4. Pay Periodically, Not All at Once
Instead of one lump payment at the end, I structure earnouts with periodic payouts quarterly or annually. This builds trust and creates ongoing alignment.
5. Cap and Floor the Amount
I make sure the earnout has a clear cap (maximum payout) and floor (minimum expectations). That clarity prevents arguments later.
6. Write Everything Into the Agreement
Verbal promises destroy trust. Every detail of the earnout, the metric, the timeline, the calculation method, and the payment dates goes into the purchase agreement in black and white.
Mistakes I’ve Made With Earnouts
I’ve made mistakes that taught me hard lessons. In one deal, I tied the earnout to EBITDA, but we disagreed later about what counted as “expenses.” The seller felt cheated. That experience taught me to define metrics precisely, leaving no room for interpretation.
In another, I let the seller push for a five-year earnout. By year three, they were disengaged, and the structure created tension instead of alignment. Now I rarely go beyond three years.
The Seller’s Psychology
Earnouts only work if the seller trusts me. If they think I’ll manipulate the numbers to avoid paying, the relationship will sour. That’s why I’m transparent about how performance will be tracked. In some deals, I’ve agreed to third-party audits to reassure the seller.
I also frame the earnout as a win for them. I say, “If the business performs as well as you believe, you’ll get the full value you want. If it doesn’t, I’m protected.” That framing makes the earnout feel fair, not adversarial.
When I Avoid Earnouts
Not every deal needs an earnout. I avoid them when:
- The business is simple and stable, with predictable revenue.
- The seller has no influence after closing.
- The relationship with the seller is strained.
Earnouts are tools, not defaults. I use them when they solve a problem, not just for the sake of complexity.
Examples From My Deals
In one acquisition, the seller was confident that new contracts in the pipeline would double revenue. I wasn’t convinced. We agreed to an earnout tied to actual revenue over the next two years. When the contracts came through, the seller was paid fully. They were happy because they proved their point, and I was happy because I didn’t overpay upfront.
In another, the seller believed key employees would stay, but I had doubts. We tied part of the earnout to employee retention. That structure gave the seller an incentive to personally reassure staff, and it worked; turnover was minimal.
Why Earnouts Protect Relationships
I’ve come to see earnouts not just as financial tools but as relationship protectors. Instead of fighting about what the business is worth, we let performance decide. That creates fairness.
Without an earnout, negotiations can stall because neither side wants to budge. With an earnout, we both take some risk and share some reward. That balance creates goodwill.
Final Thoughts
Earnouts are powerful when used wisely. They align buyer and seller interests, bridge valuation gaps, and create fairness in uncertain situations. But they only work when structured clearly, tied to simple metrics, and built on trust.
I’ve learned that earnouts are not about squeezing the seller; they’re about building a partnership through the transition. When done right, they create smoother deals and stronger outcomes for everyone.
I continue sharing my strategies on acquisitions, private equity, and real estate at DrConnorRobertson.com, where I document the lessons I’ve learned deal by deal.