An earn out pays part of the price later, on results achieved after you have handed over the controls. It exists because buyer and seller disagree about the future, and it settles that disagreement by making the seller carry the risk. Whether it is a fair bridge or a discount in disguise depends entirely on how it is measured.
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Earnout structures: the measure decides everything
Revenue is the cleanest measure because it is hard to manipulate and easy to verify. Profit is the most common and the most dangerous, because the buyer controls allocations, overhead and investment decisions that move it. Any measure below the revenue line needs protective wording about how costs are allocated, or the earn out becomes something the buyer can choose not to pay.
The earn out agreement clauses that protect a seller
An operating covenant: the buyer must run the business in the ordinary course and may not take actions designed to reduce the measure. Access to the records and a right to audit. A short period, because two years is long enough for a business to become unrecognisable. Acceleration if the buyer sells the business or terminates your involvement. And a cap and a floor that both parties can live with.
When to refuse one
When you will have no role and no influence over the measure. When the buyer intends to integrate the business into a larger one, which makes any measure below revenue meaningless. And when the earn out is a large share of the total: a deal where most of the price is contingent is a deal you have not really agreed. Treat the cash at closing as the real price and anything else as upside.
Questions people ask about earn out
How long is a typical earn out?
One to three years. Shorter is better for a seller because a business changes quickly under new ownership and the measure drifts from what you built.
Do earnout payments usually arrive in full?
Often partially. Disputes are common and they are almost always about how the measure was calculated, which is why the definition matters more than the headline number.
Is the earn out fee bearing for my adviser?
Check the engagement letter. Ask that any fee on an earn out be payable when and if you are actually paid, which firms frequently accept.
What is an earnout in M&A?
Part of the price paid later, on results achieved after you have handed over the controls. It settles a disagreement between buyer and seller about the future by making the seller carry that risk, which is why the measure it is paid on matters more than the headline number.