What is an earnout?
An earnout is a part of an acquisition price that the buyer pays only if the acquired business hits agreed targets after closing. Instead of paying everything up front, the buyer pays a fixed amount at closing and a contingent amount later, typically tied to revenue, profit, customer, or product milestones over a defined period.
Earnouts exist because buyers and sellers often disagree about the future. A seller believes growth will continue; a buyer is not sure and does not want to pay for growth that may not arrive. An earnout lets both sides agree on a deal by shifting part of that uncertainty to the seller.
In small startup and SaaS acquisitions, earnouts can unlock a deal that would otherwise stall on price. They can also become the most disputed part of the transaction. This guide explains how earnouts work, how to measure and pay them, and how to draft around the most common disputes. It is general information, not legal, tax, or accounting advice; earnout terms interact with contract law, accounting rules, and taxes in ways that need professional review.
How common are earnouts?
Earnouts are a routine tool in private M&A. SRS Acquiom's 2024 Deal Terms Study, covering more than 2,100 private-target transactions that closed between 2018 and 2023, reported that one-third of private-target deals carried an earnout provision (SRS Acquiom). A DealLawyers summary of SRS Acquiom's 2026 study reports that 24% of deals completed in 2025, excluding life sciences, included an earnout, up from 22% in 2024 (DealLawyers). The two figures appear to use different populations and definitions, so treat them as context rather than a trend line.
These studies cover transactions where SRS Acquiom provided services, mostly far larger than a typical micro-SaaS sale. They show that earnouts are mainstream, not how often they appear in a $200,000 software acquisition.
How an earnout works
Every earnout has the same building blocks.
The metric. What is measured: revenue, gross profit, EBITDA, MRR, active customers, or a non-financial milestone such as shipping an integration.
The target. The level that must be reached, such as trailing-twelve-month revenue of at least $300,000.
The measurement period. When the metric is measured, such as the 12 months after closing, or each of two consecutive years.
The payout formula. All-or-nothing, tiered, or linear. Linear and tiered formulas reduce cliff-edge disputes.
The accounting rules. How the metric is calculated, which revenue counts, how refunds and chargebacks are treated, and which accounting policies apply.
The operating covenants. What the buyer must or must not do to give the business a fair chance of hitting the target.
Payment mechanics. When the payment is calculated, who prepares the statement, how the seller can review and dispute it, and when it is paid.
Worked example
Suppose a buyer and seller agree that a SaaS product is worth $500,000 to $650,000 depending on whether growth continues. They settle on the following illustrative structure:
- Closing payment: $500,000.
- Earnout: up to $150,000, based on recurring revenue in the 12 months after closing.
- Threshold: no payment if post-closing 12-month recurring revenue is below $240,000.
- Linear scale: payment rises from $0 at $240,000 to $150,000 at $300,000.
- Cap: $150,000.
If recurring revenue comes in at $270,000, the seller is halfway between threshold and cap:
Earnout = ($270,000 − $240,000) ÷ ($300,000 − $240,000) × $150,000 = $75,000
Total consideration: $575,000. The linear design avoids the situation where $299,000 pays nothing and $300,000 pays everything, which tends to provoke arguments over every dollar near the line.
You can test how much contingent consideration changes your return with the startup acquisition ROI calculator.
Choosing the earnout metric
The metric determines how much control each party has over the result.
Revenue or MRR. Easier to measure and harder for the buyer to manipulate through cost allocations. Sellers usually prefer revenue-based earnouts. Define precisely whether you mean gross or net revenue, how refunds, chargebacks, and discounts are treated, and whether one-time revenue counts. See gross vs net revenue and MRR vs ARR.
Profit (EBITDA, gross profit, SDE). Closer to the value the buyer receives, but sensitive to how the buyer allocates overhead, salaries, and shared costs after integration. Buyers often prefer profit-based earnouts; sellers should insist on detailed accounting rules. See SDE vs EBITDA.
Customer or retention metrics. Useful when the main risk is customer loss after the founder leaves. Define the customer, the counting date, and how downgrades are treated.
Milestones. Shipping a feature, obtaining a certification, or migrating customers. These work when the outcome is binary, but they still need clear definitions and an effort standard.
For small SaaS deals, a clearly defined recurring-revenue metric is often the most workable compromise, because it is visible in billing data and less exposed to post-closing cost decisions. If revenue data comes from a payment provider, specify which accounts, products, and currencies count. Note that provider-reported totals such as RevenueBug's trailing 30-day revenue are not the same as normalized subscription MRR (methodology); the earnout definition should say which you mean.
Where earnout disputes come from
Earnout disputes usually arise because after closing the buyer controls the business while the seller's payment depends on how it performs. Common flashpoints:
- Integration decisions: moving customers to the buyer's existing product, changing pricing, or rebranding.
- Investment decisions: cutting marketing, engineering, or support spend.
- Accounting changes: reallocating costs, changing revenue recognition, or bundling products.
- Strategic change: the buyer sells the business, discontinues the product, or is itself acquired.
- Measurement ambiguity: unclear definitions of revenue, customers, or the measurement date.
Courts have treated these issues seriously. In two 2024 Delaware Court of Chancery decisions, Fortis Advisors v. Johnson & Johnson and Shareholder Representative Services v. Alexion Pharmaceuticals, buyers were found to have breached “commercially reasonable efforts” obligations attached to large milestone payments. Commentary on the decisions emphasizes that the specific drafting of the efforts standard matters more than its label, and that caveats such as “sole discretion” did not fully protect the buyer where an efforts obligation existed (Thompson Coburn). Those were very large life sciences transactions, but the drafting lessons apply to small deals too.
Drafting protections
For sellers
- Operating covenants: require the buyer to keep the product available, maintain pricing within a range, and fund a minimum level of support or marketing during the earnout period.
- Efforts standard: define what “commercially reasonable efforts” means for this product, ideally with concrete examples.
- Acceleration: make the full earnout payable if the buyer sells the business, discontinues the product, or materially breaches the operating covenants.
- Information rights: monthly or quarterly reports and access to underlying billing data.
- Security: an escrow or guarantee for the earnout if the buyer's creditworthiness is uncertain.
For buyers
- Freedom to operate: reserve the right to make ordinary business decisions, including integration, within defined limits.
- Clear exclusions: exclude revenue from products or customers the buyer brings in, and revenue from acquisitions made after closing.
- Caps and floors: cap the total earnout and use thresholds to avoid paying for growth that would have happened anyway.
- Set-off rights: allow indemnity claims to be offset against earnout payments, if agreed.
For both
- Attach a sample calculation using historical data, so both sides agree on how the formula works before closing.
- Specify a dispute-resolution path: statement, review period, objection notice, negotiation, then an independent accountant for calculation disputes.
- Keep the measurement period short enough to remain predictable. Longer periods increase the chance that business changes overwhelm the original assumptions.
Earnouts compared with other deferred payments
Seller financing is a fixed obligation: the buyer owes the amount regardless of performance, subject to the note's terms. An earnout is contingent.
Escrow and holdbacks secure the seller's representations and indemnities; the money is released unless a claim arises. An earnout depends on future performance, not past accuracy.
Rollover equity gives the seller a stake in the buyer's entity, sharing both upside and downside.
Each tool allocates risk differently, and many deals combine them. The LOI guide explains how to outline these terms before diligence.
Tax and accounting notes
Taxes on contingent payments are complicated and depend on structure, timing, and jurisdiction. In the United States, a sale where at least one payment is received after the tax year of the sale can be an installment sale, reported on Form 6252 unless the seller elects out (IRS, Topic 705). Earnouts can also raise questions about whether a payment is purchase price or compensation for the seller's continued work, which affects how it is taxed. These are exactly the questions to take to a tax adviser before agreeing the structure.
Frequently asked questions
What is an earnout in simple terms?
It is part of the purchase price that the buyer pays later, only if the business meets agreed targets after the sale. It bridges a gap between what the seller thinks the business is worth and what the buyer is willing to pay up front.
Are earnouts good for sellers?
They can be, if the alternative is a lower price or no deal. But sellers give up control over the business while their payment depends on its performance. A seller should value an earnout at less than face value, considering both the chance of hitting targets and the risk of disputes.
How long do earnouts usually last?
It varies by deal. Shorter periods are easier to predict and administer; longer periods give more time to reach targets but increase the chance that business changes overwhelm the original assumptions. Choose a period linked to the specific uncertainty being bridged.
Should an earnout be based on revenue or profit?
Revenue is easier to measure and less exposed to the buyer's cost decisions, which is why sellers often prefer it. Profit reflects value more directly, which is why buyers often prefer it. If you use profit, define the accounting rules in detail.
What happens if the buyer sells the business during the earnout?
That depends entirely on the contract. Sellers often negotiate acceleration so the full earnout becomes payable on a sale or discontinuation. Without such a clause, the seller may have limited protection.
Can I use RevenueBug data to measure an earnout?
Parties can agree on any data source, but they must define the metric precisely. RevenueBug's headline figure is trailing 30-day revenue calculated from connected payment providers, not subscription MRR or audited revenue. An earnout agreement should define its own metric and the data it relies on.