Software Growth

Earnout

An earnout is part of an acquisition price paid later, only if the business hits agreed targets such as revenue, ARR or retention after the sale.

An earnout defers part of the purchase price and ties it to what the business does after closing. The buyer pays an upfront amount, and the rest only if targets are met. It usually shows up when buyer and seller disagree about the future: you believe growth will continue, the buyer wants proof first.

How it works

Clearly Acquired describes the typical structure: an upfront payment, with the rest deferred against metrics such as revenue growth, EBITDA or customer retention, paid over one to five years, with two to three years standard in small deals. They also report that in most small deals 10 to 50 percent of the price is deferred this way.

Example: a SaaS sells for $600,000. The deal is $450,000 at closing and $150,000 (25 percent) as an earnout over two years, payable if ARR stays at or above $400,000. If ARR holds, you receive the full $150,000. If it falls to a level the contract sets as a failure, you may receive nothing. Some contracts pay proportionally, others pay all or nothing. The formula above applies only to proportional deals.

Risks for sellers

  • After closing, the buyer controls the product, pricing and marketing, so they affect whether you hit the target.
  • Vague metric definitions cause disputes. Define ARR, churn and what counts as a customer in the contract.
  • You may be bound to stay and work in the business during the earnout.

Protections include floors (minimum payment), clear metrics, covenants limiting what the buyer can change, and dispute resolution by an expert or arbitrator. Treat the earnout as risky money when you compare offers: a lower all-cash price can beat a higher headline price with a large earnout.

Why buyers ask for them

Earnouts show up when there are red flags such as customer concentration or a founder who runs everything. They transfer risk back to the seller. Negotiate them in the letter of intent, and see Rob Walling and Sherry Walling's book Exit Strategy for the emotional side of staying on after a sale. This is general information, not legal or tax advice.

Sources

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