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earn-out

Also called: earnout, earn out

Part of a company's sale price that is paid only if the business reaches agreed goals after the sale, usually while the founder keeps working in it. The safest approach is to treat it as a possible bonus, not guaranteed money.

An earn-out is the part of a company's sale price that the buyer pays only if the business reaches agreed targets after the sale, usually revenue or profit within a year or two, and usually while the founders keep working in it. It bridges a gap: the seller believes the business will keep growing, the buyer isn't sure, so part of the price depends on what actually happens.

The details decide whether an earn-out is fair. What exactly is measured (MRR, revenue, profit), by whom, over what period, and is it all-or-nothing or paid in proportion? Crucially, after the sale the buyer controls the business: they can change prices, merge the product, move the team or cut the marketing budget, and every one of those decisions can make the target unreachable. A fair earn-out limits what the buyer can change, or protects the seller if they do.

The safe way to evaluate an offer with an earn-out is to treat the earn-out as a possible bonus and ask: would I accept the money at closing alone as the price? If yes, the earn-out is upside. If not, negotiate more at closing, a lower target, or proportional payment, rather than hoping.

Example

In October of year 2 GarageDesk's MRR is 165,000 UAH. A buyer offers 6,000,000 UAH: 4,000,000 at closing plus a 2,000,000 earn-out if MRR reaches 200,000 UAH a year after closing, when the buyer runs the budget, the prices and the team.

After negotiation the deal is 5,000,000 UAH at closing plus a 1,000,000 earn-out if MRR reaches 190,000 UAH within 12 months. In January about 60 shops move from the old 600 UAH to 750 UAH, taking MRR to 174,000 UAH, so the new target is a 190,000 / 174,000 − 1 ≈ 9.2% rise. The founders give the old target about a 50% chance and the new one about 80% (their own estimates): expected value 4,000,000 + 0.5 × 2,000,000 = 5,000,000 before, 5,000,000 + 0.8 × 1,000,000 = 5,800,000 after. And they check first that 5,000,000 alone is a price they'd accept.

Common mistakes

  • Counting the earn-out as money in the bank. Plan your life around the closing payment only.
  • Vague targets. Define the metric, how it's measured and who measures it, in writing.
  • Ignoring the buyer's control. Price changes, product merges or budget cuts can kill the target; limit them in the contract.
  • All-or-nothing payouts. Reaching 95% of the target should not pay zero; ask for a proportional scale.