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Earnouts

Future payments tied to post-sale performance, used to bridge valuation gaps but risky for the seller.

What an Earnout Is​

An earnout is a portion of the purchase price the buyer pays only if the business hits specific targets after the sale closes. Burlingham defines it as "portion of the sale price paid over time and contingent on the company's post-sale performance." Warrillow frames it as the part of the price "tied to hitting future targets while the seller stays on," typically running one to seven years, with three years being the average.

The earnout sits opposite the guaranteed portion of an offer, which Warrillow calls the downstroke: "the up-front cash portion of an offer (vs. the earnout portion)." Two offers with the same headline number can be wildly different deals depending on how much is guaranteed cash and how much is contingent on a future the seller no longer controls.

Why Buyers and Sellers Use Them​

The earnout exists to bridge a gap. When the buyer and seller disagree on what the business is worth, the earnout lets the buyer pay the higher number only if the optimistic case proves true. As McDannell puts it, earnouts "can justify a higher price but tie payout to the business's performance in someone else's hands." They are one ingredient in creative deal structuring, combined with cash, seller notes, and equity to shape the total consideration.

In Warrillow's framework, accepting an earnout is one of four post-sale roles a seller can choose. The earnout corresponds to the "Division Executive" role: you stay on, run your former company inside the buyer's organization, and trade guaranteed cash for larger potential upside.

The Risk to the Seller​

All three sources warn that the earnout shifts risk onto the seller. Burlingham is blunt:

"Earnouts transfer all risk to the seller while removing the buyer's incentive to help; most end early."

Burlingham, Finish Big, ch. 8

Warrillow agrees that the new owner controls the P&L and has little reason to help the seller hit targets, so much of the earnout "may be just an illusion." His advice is to treat anything beyond the downstroke as a bonus. Quoting Rod Drury:

"I never counted the earnout... I think [you should count an] earnout as a bit of a bonus."

Warrillow, The Art of Selling Your Business, ch. 15

McDannell goes furthest, listing earnouts among the things to avoid:

"Avoid earnouts at all costs, especially ones requiring full-time involvement -- and cap seller carry/earnouts at ~20%."

McDannell, Get Acquired, ch. 6

Negotiating Safer Terms​

If an earnout is unavoidable, the sources converge on a few protections. First, never let cash at closing fall below your minimum acceptable number. Warrillow's rule is to protect the downstroke and treat structured upside as gravy, not as real proceeds.

"Treat the earnout as gravy... never let cash-at-close fall below your minimum."

Warrillow, The Art of Selling Your Business, ch. 15

Second, cap the contingent portion. Both McDannell and Burlingham point to roughly 20% as a ceiling on combined seller carry and earnout exposure. Third, Warrillow recommends negotiating a time delay so the earnout clock starts after integration (for example, three months in) rather than on day one, when the disruption of the handoff is at its worst.

Further Reading​

Sources: McDannell, Get Acquired ch.6; Warrillow, The Art of Selling Your Business ch.15; Burlingham, Finish Big ch.8.