An earnout is a form of deferred payment to the seller that is contingent on certain events occurring post-closing. An earnout can be tied to revenue, EBITDA, or a non-financial metric such as retention of key employees or the issuance of a patent.
An earnout is contingent purchase price. The seller receives extra payments after closing if the business hits agreed targets. Typical windows run one to three years. Buyers use earnouts to bridge a valuation gap when they will not pay the seller's full ask in cash.
The metric matters more than the headline amount. Revenue and client retention sit higher on the P&L. They are easier for a seller to influence and verify. EBITDA and net income sit lower. The buyer controls costs, allocations, and accounting after close, so those metrics create more dispute risk. Deal counsel typically flags revenue as harder to manipulate and net income as easier for the buyer to shrink.
Tax treatment follows the paper. Payments treated as purchase price can qualify for capital gains and installment reporting. Payments treated as compensation are ordinary income. Employment-conditioned earnouts tilt toward compensation. Sellers should separate market-rate pay from the earnout and keep definitions tight enough that a later accountant can compute the number without a fight.
Buyer credit risk remains. An earnout is an unsecured promise unless the agreement adds escrow, a parent guarantee, or acceleration on a resale. Limited operating control after close is the core risk. Ordinary-course covenants, reporting rights, and independent-accountant dispute procedures are the usual protections.