Earnouts in Business Sales: What You’re Being Offered and How to Negotiate It

You are at the closing table, figuratively, at least. The buyer has made an offer. The headline number looks good. Then the advisor explains the structure: $8M at close, and up to $4M more over the next three years if the business hits certain revenue and EBITDA targets.

Congratulations. You have been offered an earnout.

Now here is the thing nobody tells you at that moment: across all M&A deals with earnout provisions, sellers collect about 21 cents on the dollar of the maximum earnout amount, according to SRS Acquiom’s 2024 M&A Deal Terms Study. Deals where the targets are achieved pay out about half the maximum. Deals where they are not achieved pay out nothing.

That $4M in “up to” consideration statistically becomes something between $0 and $2M, with the most likely outcome somewhere in the middle, and that is before accounting for the disputes, the buyer behavior post-close, and the very human experience of working for your acquirer while watching your earnout targets get harder to hit.

An earnout is a form of contingent consideration in a business sale where a portion of the purchase price is paid post-closing based on the acquired business hitting specified financial or operational targets. Buyers use earnouts to bridge valuation gaps and manage risk. Sellers who accept earnouts are betting that the business will perform AND that the buyer will run it in a way that makes hitting the targets possible.

Understanding what you are actually agreeing to is the first step to negotiating it well.

Key Takeaways

• 13% of lower middle market deals included earnouts in 2024, with nearly half of those earnouts representing 50% or more of the total purchase price, per Seyfarth Shaw’s M&A Survey.
• Earnouts pay approximately 21 cents on the dollar across all deals, per SRS Acquiom 2024 data. Deals where targets are achieved pay about 50 cents on the dollar.
• The most common earnout dispute: buyers change operations after closing in ways that make hitting the earnout targets structurally impossible.
• Delaware courts have ruled in favor of sellers in 6 of 7 recent major earnout cases, putting pressure on buyers to settle rather than litigate.
• The best earnout protection is an anti-manipulation covenant, a clause requiring the buyer to operate the business in a manner that does not intentionally reduce earnout payouts.

Why Buyers Offer Earnouts (And Why Sellers Take Them)

From the buyer’s perspective, an earnout is a risk management tool. When a seller is projecting strong growth, “we’re going to do $5M in EBITDA next year, we’ve been at $3M”, a buyer who is not sure they believe that projection will often say: fine, if you hit $5M, we’ll pay you for a $5M EBITDA business. If you hit $3M, we’ll pay you for a $3M EBITDA business. The earnout turns the seller’s optimism into the seller’s risk.

From the seller’s perspective, earnouts can look attractive for a few reasons. They allow a seller to achieve a higher headline price than the buyer would pay upfront. They can bridge a valuation gap when buyer and seller cannot agree on what the business is worth today. And for sellers who plan to stay involved in the business post-close, they represent upside tied to continued performance.

The tension emerges when the seller exits after closing and the buyer’s operational decisions make hitting the earnout targets harder or impossible. This is not hypothetical, it is the most common earnout dispute in lower middle market M&A, and Delaware courts are full of these cases.

How Earnouts Are Structured

Earnouts have four components you need to understand before you sign.

The metric. What is being measured, revenue, EBITDA, gross profit, or an operational milestone? EBITDA earnouts are the most common in the lower middle market, but revenue earnouts are also used. The choice matters significantly. Revenue is harder to manipulate after close, a buyer cannot easily decide to run fewer sales initiatives in a way that reduces revenue without it being obvious. EBITDA is easier to manipulate, a buyer can increase expenses allocated to your division in ways that reduce the reported EBITDA without touching revenue at all.

If a buyer offers you an EBITDA earnout, your negotiating position should include either revenue as a parallel or alternative metric, or robust accounting protections that specify exactly how EBITDA will be calculated.

The performance period. How long does the earnout run? One year, two years, three years, longer? Shorter earnout periods, one to two years, are generally better for sellers because there is less time for the buyer to alter operations, the business has less opportunity to miss targets due to factors outside your control, and the payout uncertainty resolves faster. Recent data shows a trend toward shorter performance periods, with fewer deals having earnout periods longer than four years.

The targets and payout schedule. What specific numbers trigger payment, and how does the payout scale? A binary earnout, hit the target, get the full amount; miss it, get nothing, is the riskiest structure for sellers. A tiered earnout that pays proportionally between a floor and a ceiling is significantly better. The difference between “miss by 5% and get nothing” and “miss by 5% and get 80% of the earnout” is enormous in practice.

The anti-manipulation covenant. This is the most important protective provision in any earnout structure and the one most sellers fail to negotiate. An anti-manipulation covenant requires the buyer to operate the business in a manner consistent with past practice, or at minimum, not to operate it in a manner intentionally designed to reduce earnout payments. Without this clause, the buyer has every economic incentive to reallocate expenses, delay revenue recognition, or shift business away from your division in ways that make hitting your targets impossible.

The Disputes Nobody Mentions at the Time of Signing

Delaware courts have seen a significant increase in earnout litigation as earnouts negotiated during the 2021-2023 period reach the end of their performance windows. Harvard Law’s Corporate Governance Forum found that in six of seven recent major earnout decisions, Delaware courts ruled in favor of the seller seeking earnout payments. This is good news if you end up in litigation. It is much better news to never need it.

The most common disputes:

Accounting method changes. The buyer acquires your business, integrates your financials into their larger entity, and suddenly applies a different accounting methodology that reduces your reported EBITDA. Your earnout targets do not change. Your ability to hit them does.

Expense allocation. The buyer allocates corporate overhead, management fees, or shared services costs to your division at levels that did not exist before the acquisition. Your revenue holds. Your EBITDA falls. Your earnout misses.

Business decisions that reduce your revenue. The buyer discontinues a product line, loses a customer due to integration disruption, or redirects your sales resources to other priorities. Your division underperforms through no fault of the pre-acquisition business.

The “operated in accordance with buyer practices” argument. After an earnout miss, buyers sometimes argue they were not required to run the business the way the seller ran it, they were required to run it consistent with their own operating practices. If the purchase agreement language supports that interpretation, sellers have limited recourse.

The protection against all of these is clear, specific language in the purchase agreement, negotiated before you sign, not discovered after the earnout misses.

How to Negotiate an Earnout That Actually Protects You

Negotiate the metric. Push for revenue over EBITDA, or insist on both metrics where at least one must be hit for the earnout to pay. If EBITDA is unavoidable, define it precisely, specify what expenses can and cannot be included, how corporate overhead will be allocated, and whether the calculation uses the same methodology as pre-acquisition financials.

Push for a shorter period. One to two years is better than three to four. Every additional year adds compounding risk from buyer operational changes, market conditions outside anyone’s control, and the human dynamics of working inside an organization that acquired you.

Demand tiered payouts, not binary targets. A structure that pays proportionally between 80% of target (partial payout) and 120% of target (full payout plus potential bonus) is far better than a binary on/off threshold.

Insist on the anti-manipulation covenant. This should be explicit: the buyer must operate the business in a manner not intentionally designed to reduce earnout payments. Some buyers push back on this. Those are the buyers who intend to manipulate the earnout.

Require information rights. You should have the right to review the relevant financial statements, challenge accounting decisions, and access the data necessary to verify earnout calculations on a regular basis, monthly or quarterly, not just at the end of the performance period.

Include a dispute resolution mechanism. Specify an independent accountant or arbitration process for disputes, with defined timelines. Without this, a dispute over earnout calculations can drag on for years.

When to Refuse an Earnout

There are circumstances where the right answer is to refuse the earnout entirely and either negotiate for more cash at close or walk away from the buyer.

Refuse an earnout when the buyer’s track record with other acquisitions raises questions about post-close integration and earnout payment behavior. Due diligence on the buyer’s history is legitimate and advisors can help with it.

Refuse an earnout when the performance period is long (three or more years) and the targets are aggressive relative to the business’s historical performance.

Refuse an earnout when the metric is EBITDA and the buyer cannot or will not accept robust accounting protections and the anti-manipulation covenant.

Refuse an earnout when the earnout represents more than 25-30% of the total consideration and you are planning to exit the business entirely after closing. The combination of high earnout percentage and no ongoing involvement is the riskiest possible position for a seller.

An earnout is a tool. Like any tool, it has legitimate uses and situations where it will cause harm. Understanding which situation you are in is the whole game.

Frequently Asked Questions

What is an earnout in a business sale?

An earnout is a form of contingent consideration where a portion of the purchase price is paid after closing, based on the acquired business hitting specified financial targets, usually revenue or EBITDA, over a defined performance period. Buyers use earnouts to manage risk when seller and buyer disagree on the future value of the business.

Do earnouts actually pay out?

Not as often as sellers expect. SRS Acquiom’s 2024 data shows earnouts pay about 21 cents on the dollar across all deals. Deals where performance targets are achieved pay about 50 cents on the dollar of maximum earnout value. The gap between the headline number and the actual check is real and often larger than sellers anticipate.

What is the most important thing to negotiate in an earnout?

The anti-manipulation covenant, a clause requiring the buyer to operate the business in a manner not intentionally designed to reduce earnout payments. Without this, the buyer has economic incentives to make operational decisions that legitimately reduce your earnout without exposing them to liability.

Should I accept an EBITDA or revenue earnout?

Revenue earnouts are generally safer for sellers because they are harder to manipulate through expense allocation and accounting methodology changes. If EBITDA is unavoidable, insist on precise definitions of how EBITDA will be calculated, what expenses can be included, and how overhead will be allocated post-close.

Can I sue a buyer if my earnout is not paid?

Yes, and recent Delaware court decisions have favored sellers in earnout disputes. However, litigation is expensive, unpredictable, and takes years to resolve. The better strategy is robust protective language in the purchase agreement before you sign, not litigation after the earnout misses.

Daniel Askew is the Founder and CEO of Icon Business Advisors, a Nashville, Tennessee M&A advisory firm. Icon has advised on earnout negotiations across the Southeast lower middle market.

[Talk to an M&A Advisor About Your Deal Structure], Before you sign the LOI, understand what you are agreeing to.

Call us directly: (615) 931-0001

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