By Andreas Pettersson, Founder, Leaders ADAPT
The buyer loves your company. Just not enough to pay for all of it today. The letter of intent splits the price in two: a check at closing, and a second amount that arrives later, if the business hits numbers you'll no longer fully control. That second part is an earnout, and in 2025 it showed up in 24 percent of private deals outside life sciences (SRS Acquiom, 2026).
The definition this guide uses: An earnout is the part of a company's purchase price that the buyer pays after closing only if the business reaches agreed targets, such as revenue or EBITDA, within a set period. Lawyers call it contingent consideration.
I was paid through one. Below: the structure table, the seven clauses that decide whether the money arrives, and the Skin in the Game test seen from the seller's chair.
Quick answer: An earnout is deferred, contingent purchase price. The seller receives a fixed amount at closing and further payments later if the business meets targets written into the purchase agreement, most often revenue or EBITDA, over a period that usually runs one to three years. Payments typically follow each measurement period, are capped at a maximum, and depend on how the buyer operates the business after closing.
How does an earnout work?
You price in the growth you can see coming. The buyer prices in the risk that it won't come. The earn-out bridges the gap: pay for what exists today, and for the growth if it shows up.
The mechanics run in five steps:
- The letter of intent sets the split. A closing payment plus a maximum contingent amount. In the 2026 SRS Acquiom study, the median potential was 34 percent of the closing payment, up from 31 percent (Fasken, May 2026).
- The earnout agreement defines the target. Usually a section of the purchase agreement: metric, accounting rules, measurement periods, payment formula.
- The business runs under the buyer. You stay as CEO, move into another role or leave.
- Each period gets measured. The buyer prepares a statement, you review it, disputes go to a named referee.
- The buyer pays what was earned. All or nothing, or on a sliding scale, up to the cap.
Here's the problem. Step three is where the money is won or lost, and it's the one step no lawyer can draft for you.
The earnout structure table: six terms that set the deal
Every deal comes down to six terms: what each sets, what the market data says, and where each side pulls.
| Term | What it sets | Market reference (sourced) | Seller usually pushes for | Buyer usually pushes for |
|---|---|---|---|---|
| Metric | What has to be achieved | Revenue is the most common metric, then earnings or EBITDA; EBITDA is often the compromise (Harvard Law School Forum, 2025) | Revenue or gross profit, harder to move with cost allocations | EBITDA or net income |
| Period | How long performance is measured | 1 to 2 years in 38 percent of deals, 1 year or less in 23 percent, 2 to 3 years in 20 percent (SRS Acquiom study via Fasken, 2026) | Shorter, while the seller still knows the business | Longer, to see growth hold |
| Cap and floor | The most that can be paid, and any minimum | Median potential 34 percent of the closing payment (SRS Acquiom study via Fasken, 2026) | A higher cap and a sliding scale | A hard cap and all or nothing thresholds |
| Payment schedule | When earned amounts are paid | Commonly after each annual or multi year measurement period | Annual tranches with catch up | One payment at the end |
| Control covenants | How the buyer must run the business | In an ABA study of 2022 to early 2023 deals, 25 percent had at least one major operating covenant (Harvard Law School Forum, 2025) | Standalone operation, separate books, no starving of resources | Freedom to integrate |
| Acceleration | When the full amount becomes due early | Almost 25 percent of non life science deals closed 2014 to 2023 accelerated on a change in control (Harvard Law School Forum, 2025) | Acceleration on resale, covenant breach or termination without cause | None, or change in control only |
Every Harvard Law School Forum row comes from The Art and Science of Earn-Outs in M&A, written by A&O Shearman lawyers.
How long does an earnout last?
Outside life sciences, the median earnout period is 24 months; in life sciences, milestone payments commonly run three to five years or more (Harvard Law School Forum, 2025).
Mine ran longer.
My earnout: seven years on paper, paid out over four
Canon acquired Arcules, the AI and cloud video business I built from founding to 150+ employees. The structure was seven years on paper. I was paid out over four of them. No figures or terms beyond that; the lesson doesn't need them.
Here's what the receiving side teaches you. The headline price is a promise. The definitions section is the deal.
And the team has to deliver the number. During those years I was one of Canon's youngest CEOs, running a standalone company inside a far larger one. The agreement wasn't a document I filed away. It was the leadership team's scoreboard every quarter.
Reasons aren't results. No buyer pays for a good explanation of why the number was missed.
The seven clauses that decide whether you get paid
SRS Acquiom's summary of its data: "overall, closer to one out of five dollars gets paid across all deals with an earnout" (SRS Acquiom, 2026). These clauses move a seller toward the right side of that number.
- The metric definition. Name the metric and the accounting rules: consistent with past practice, the same revenue recognition, no new corporate overhead charged in. If you don't measure, you can't manage. If you don't define, you can't collect.
- The operating covenants. Run the business consistent with past practice, as a standalone unit with separate books and minimum working capital, without selling off parts of it.
- The efforts standard. A duty to use commercially reasonable efforts toward the target. Delaware courts have treated the common variants, such as "reasonable best efforts", as largely interchangeable (Harvard Law School Forum, 2025), so the listed actions matter more than the adjective.
- Acceleration. The full amount comes due if the buyer resells the business, breaches a covenant or integrates it so the metric can't be measured.
- Your role and the leaver terms. If the payout depends on you running the business, your employment terms must match it. What happens to the payments if you're terminated without cause?
- Set-off. Buyers often want to deduct indemnity claims from earned payments. Limit that to finally decided claims, or route claims through escrow instead.
- Information, audit and disputes. Monthly reporting, access to the books behind each statement, and a named independent accountant who rules on disputes within fixed days.
Vice Chancellor Laster of the Delaware Court of Chancery put it plainly: "an earn-out often converts today's disagreement over price into tomorrow's litigation" (Harvard Law School Forum, 2025). The bigger the contingent share and the longer the period, the article notes, the more likely a dispute.
Why the company has to keep performing after you hand it over
Most guides treat this as a legal problem. It's a leadership problem with a legal wrapper.
The day you sign, the buyer controls the budget, the systems and often the sales priorities. What you still control is whether the team you built can hit the number without you making every call. If the company only performs when you're in the room, you're being paid to stay in the room, and the first reorganization takes the room away.
In our 2026 coaching data, 55 percent of 84 owner CEOs raised hiring and team performance, and only 20 percent raised succession (Leaders ADAPT, 2026). The team is on the radar. The handover rarely is, until a letter of intent forces it.
Three moves protect the payout before it exists:
- Score your owner dependence. The Owner Dependence test in the exit strategy guide shows how much of the business still runs through you. Every "no" is payout risk.
- Name the successor for your seat. The Successor Readiness checklist for owners tells you whether the person running the business during the period is ready, or just available.
- Pick one lever. At Arcules I once ran 47 priorities at the same time and learned what that costs. During the period, the team chases the one metric in the agreement and builds a true second in command.
Selling a business with an earnout vs buying out a business partner
My rule for owners whose business partner wants out: never raise growth capital to buy out a business partner. Give the departing partner a ramping earn-out tied to revenue instead.
Capital spent on a buyout buys nothing that grows the company. A ramping payout comes from revenue the business actually produces, so payments rise as revenue grows and the company never borrows against a future it hasn't earned.
Move sooner rather than later, because the buyout cost rises as the business grows. Model the formula in a spreadsheet first, so the offer is framed against a formula, not an arbitrary number.
Get counsel on the cap table before you sit down. If the person leaving holds a profits interest in an LLC rather than capital, the math changes again. And if you replace the departing owner's know-how with an outside advisor, read advisor equity and the advisor agreement next.
How is an earnout taxed?
The IRS defines an installment sale as "a sale of property where you receive at least one payment after the tax year of the sale", and a contingent payment sale as "one in which the total selling price can't be determined by the end of the tax year of sale" (IRS Publication 537, 2025). Most of these deals fit the second definition, governed by Regulations section 15a.453-1(c).
The same publication warns that deferred payments with little or no stated interest can carry unstated interest, taxed as ordinary income. Separately, whether payments tied to your continued employment count as purchase price or as pay is a point to settle before signing.
The plain rule on documents: your attorney and your CPA sign off on the purchase agreement, the payment schedule and its tax treatment before you do.
Should you accept an earnout when selling your business?
Accept one when three things are true: the price gap is about future growth you genuinely believe in, the metric is one your team can move after closing, and the seven clauses are in the agreement.
Push for more cash at closing, or walk, when the metric depends on the buyer's decisions, integration starts on day one, or most of the price sits in a long period.
Then run the Skin in the Game test from the phantom equity guide clause by clause. It was built for owners granting equity like instruments. A contingent price is the same bet from the receiving side.
Earnout FAQ
What is an earnout?
An earnout is a portion of a business's purchase price that the buyer pays after closing only if the business meets agreed targets during a set period. Targets are usually revenue or EBITDA. The structure bridges a valuation gap: the seller receives a fixed closing payment for the business as it stands, plus contingent payments if forecast growth is achieved. SRS Acquiom reported such provisions in 24 percent of private non life science deals in 2025.
How long does an earnout last?
Most run one to three years. In the 2026 SRS Acquiom Deal Terms Study, 38 percent of contingent payment periods ran one to two years, 23 percent one year or less and 20 percent two to three years, according to a Fasken summary. A 2025 A&O Shearman analysis put the median outside life sciences at 24 months, with life sciences milestones often running three to five years or more.
How is an earnout paid?
Payment is usually in cash after each measurement period, once the buyer delivers a statement and any review period ends. It can be all or nothing on a threshold, proportional on a sliding scale, or split into annual tranches with catch up provisions. Some agreements allow the buyer to pay in stock or to offset indemnity claims, and most cap the total amount.
What are typical earnout terms?
Typical terms define the metric, the accounting principles, the measurement period, the maximum payment and the payment schedule. Sellers negotiate operating covenants, an efforts standard, acceleration events, information and audit rights, and a dispute process with an independent accountant. In the 2026 SRS Acquiom study, the median contingent potential was 34 percent of the closing payment.
How is an earnout taxed?
In the US, a sale with payments after the year of sale is an installment sale, and one whose total price cannot be determined by year end is a contingent payment sale under IRS Publication 537, governed by Regulations section 15a.453-1(c). Deferred payments with little or no stated interest can create unstated interest or original issue discount, taxed as ordinary income in the year it accrues.
How do sellers protect an earnout?
Sellers protect the payout with a precise metric definition tied to past accounting practice, operating covenants that keep the business measurable, an efforts standard, acceleration on resale or breach, limits on set-off, regular reporting with audit rights, and a fast independent accountant process for disputes. Matching the seller's employment terms to the payment terms prevents a termination from cutting off payments.
The price you agree to is the price your team has to earn
A contingent price turns part of your sale into a performance target for a company you no longer own. The clauses decide whether a hit target gets paid. The team decides whether it gets hit.
Sellers who collect prepared both: the definitions, and a company that performs when the founder is one voice among several.
Make the second half of the price collectible: how 1:1 CEO advisory prepares the team
My 1:1 CEO advisory works on the half of the deal no attorney can draft. It opens with one call that names the people your payout will depend on. The first 90 days: assessments for you and your leaders, a written intake answered by voice memo, an in person working session, and a six month plan with no more than three priorities.
For a seller, the priorities usually include your Owner Dependence score, a successor for your seat, and the target metric turned into a weekly number one leader owns. There's one more piece, the document I ask every selling CEO to write before the letter of intent is signed, and I'll walk you through it on the call.
For the right company, I'll tie part of my own pay to results through an equity like instrument that expires if the results don't arrive.
Fast forward to the second anniversary of closing. The statement arrives, the number is met, and the meeting that reviewed it ran without you.
Tomorrow morning, write down the one metric a buyer would most likely put in your earnout, and the name of the person who'd own it if you were gone. Bring both to a 1:1 CEO advisory conversation.
