Earnout

A contractual provision in an acquisition where the seller conducts future compensation based on the business's performance.

An earnout is a contractual provision in a merger or acquisition (M&A) agreement where the seller of a business receives additional compensation in the future if the business achieves pre-determined financial or operational targets. These targets are typically tied to metrics like revenue, net income, or product milestones over a specified period after the transaction closes. This mechanism helps bridge valuation gaps between buyers and sellers, especially for high-growth startups or companies with unproven business models. It reduces risk for the buyer by ensuring they only pay the full premium if the acquired company performs as promised, while giving the seller a chance to capture upside. For investors, earnouts are critical to monitor because they represent contingent liabilities for the acquiring company and potential future cash inflows for the seller. High earnout structures can sometimes lead to post-acquisition disputes over how the business is run and how metrics are calculated, which can disrupt integration and impact shareholder value.

Company A acquires Startup B for an upfront payment of $100 million. The contract includes an earnout clause stating that if Startup B generates $50 million in revenue during the first year post-acquisition, the founders will receive an additional $20 million. If Startup B achieves $52 million in year-one revenue, the target is met, making the total acquisition cost $120 million ($100 million + $20 million).