Earnout agreements: how they work and where sellers get hurt.

An earnout is the part of your sale price you only receive if the business hits agreed targets after completion, typically 10-40% of the headline number, measured over one to three years against revenue or EBITDA. An offer of £10m with £4m in earnout is not a £10m offer; it is £6m guaranteed and a £4m bet on performance you may no longer control. Whether that bet pays out depends almost entirely on the drafting.

What is an earnout and how does it work?

The mechanics sit in a schedule to the sale and purchase agreement. It defines a metric (revenue, gross profit or EBITDA), a target for each measurement period, and the payment due when the target is met. A simple version: you sell for £8m, take £6m at completion, and receive up to £1m in each of the next two years if EBITDA stays above £1.5m. Some earnouts are all-or-nothing against a single hurdle; better ones pay on a sliding scale, so hitting 90% of target earns 90% of the tranche rather than zero.

Two consequences follow. First, the earnout is measured inside a business the buyer now owns and runs, you are betting on numbers someone else controls. Second, every defined term moves real money: what counts as revenue, which costs hit EBITDA, how group charges are allocated. Owners who negotiate the headline price hard and the definitions casually have the effort exactly backwards.

Why do buyers propose earnouts?

Three reasons, and only one of them should worry you.

• To bridge a valuation gap. You believe the forward year justifies a higher price; the buyer will only underwrite trailing numbers. The earnout lets both sides be right: if the forecast lands, you get paid for it.
• To de-risk the transition. Where the business leans on you, key customer relationships, supplier terms, the senior team, the buyer is paying for something that could walk out the door. Deferring part of the price keeps you committed through handover.
• To finance the deal. Some buyers propose earnouts because they cannot fund the full price at completion. That is a credit risk dressed as a valuation mechanism. Ask how the deferred amount is secured, and treat an evasive answer as your answer.

Earnouts appear most often where recent growth is steep, earnings quality is contested, or adjusted EBITDA add-backs make up a large share of the profit number. The cleaner and better-evidenced your figures, the smaller the earnout a buyer can justify asking for.

How are earnouts typically structured?

The single biggest structural choice is the metric. A revenue target is hard for a buyer to distort: sales are sales, wherever costs get booked. An EBITDA target imports the buyer's entire cost base into your payout, their management charges, their allocated overhead, their integration spend. Gross profit sits between the two and is often the workable compromise: it captures margin quality without exposing you to overhead decisions you do not control.

Buyers push for EBITDA because it stops you buying revenue with margin. Sellers should concede it only with the definition, the cost allocations and a worked example fixed in the agreement. The second choice is the payout curve: a graduated scale from a floor to a cap keeps you paid for near-misses; a single cliff turns a 5% shortfall into a 100% loss of the tranche.

Typical earnout terms: the numbers

Ranges we see in lower-mid-market deals:

• Share of total price. 10-25% is standard; 30-40% signals a genuine valuation gap or a buyer short of funding. Above 50%, you are not selling the business, you are lending it to the buyer.
• Term. 12-36 months. Beyond three years the link between your handover and the result breaks down; push longer terms back or price them as lost.
• Metric. Revenue or gross profit where you can get it; EBITDA only with locked definitions. In founder-dependent services businesses, buyers usually insist on a profit measure.
• Targets. Best set at or modestly above current run-rate. A target requiring 30% growth before anything pays is a price cut dressed as an incentive.
• Payout curve. Graduated from roughly 80-90% of target, often capped at 100-120% of the tranche. Avoid all-or-nothing hurdles.
• Comparing offers. In our deals we compare bids by discounting the earnout portion to 50-70% of face value, adjusted for how much control the seller keeps over the metric. A £9m offer with £1m deferred routinely beats a £10m offer with £4m deferred.

Structures vary by sector, software deals carry different terms from distribution, so check what buyers actually paid, and how, in our comparable transactions tool.

Where do earnouts go wrong for sellers?

The core problem is structural: the person who owes you the money controls the number that triggers payment. The common failure modes:

• Cost loading. Group management charges, allocated head-office overhead and integration costs land on your P&L, and the EBITDA target quietly recedes.
• Integration effects. The buyer merges operations, migrates customers onto their contracts, folds your entity into theirs, and your standalone revenue becomes unmeasurable, or measurable only on their terms.
• Strategy changes. The buyer deprioritises your product line, raises prices to harvest margin, or cuts the marketing budget. Rational for them over five years; fatal for your revenue target over two.
• Accounting policy changes. Revenue recognition, provisioning and capitalisation choices all move EBITDA with no change in the underlying business.
• Your own position. If the payout depends on you staying and the relationship sours, the buyer holds both your job and your deferred price.

None of this requires bad faith. Ordinary integration does most of the damage on its own, which is why the protections must be contractual, not relational.

How do you negotiate an earnout that actually pays?

1. Pick a metric high in the profit and loss account. Revenue or gross profit over EBITDA wherever your leverage allows.
2. Define everything, with a worked example. The agreement should include a specimen calculation so there is nothing left to argue about at measurement date.
3. Ring-fence the business. Standalone management accounts, consistent accounting policies, and a cap or outright bar on group cost allocations during the earnout period.
4. Add operating covenants. The buyer commits to fund the agreed budget, maintain sales capacity and not divert customers or opportunities to other group companies.
5. Add acceleration triggers. Full payout falls due on an onward sale of the business, insolvency events, or your removal without cause.
6. Secure information and audit rights. Monthly management accounts, the right to audit the earnout calculation, and a fast dispute route to an independent accountant.

The strongest protection is one you cannot draft: competition. A sole buyer dictates structure; several buyers at the table compete on cash at completion. That is much of the argument for a properly run sell-side process, across ours, 93% of mandates taken reach close, and terms improve when a buyer knows another offer sits behind them. It is also why preparing the business before going to market matters: clean, defensible numbers shrink the earnout a buyer can argue for in the first place.

What to do next

Before responding to any offer with deferred consideration, establish what the business is worth in cash terms, our free 10-question valuation tool gives you an indicative range in minutes to benchmark the guaranteed portion against. If you are already holding an offer and want operator-level eyes on the structure before you sign anything, talk to us.

Frequently asked questions