If you are a founder staring at a Letter of Intent (LOI) today, there is a 33% chance it includes an earnout. If you are in the technology sector, that probability jumps even higher. The buyer is offering you a tantalizing headline number—perhaps $50M—but $15M of that is contingent on future performance. You look at your growth trajectory and think, "We'll hit those numbers easily."
Stop. You are falling into the classic valuation gap trap. Buyers use earnouts not to incentivize you, but to bridge the difference between what you think your company is worth and what they are willing to risk. Once the ink is dry, their incentives shift immediately from "growth" to "integration efficiency."
The data is brutal. According to SRS Acquiom's 2024 M&A Claims Insights Report, the average earnout pays just 21 cents on the dollar across all deals. Even in deals where some payment is made, sellers typically receive only half of the maximum potential amount. Worse, 28% of these arrangements end in formal disputes. An earnout isn't a bonus; it's a deferred payment the buyer hopes they never have to release.
For a founder like you—who has spent years building a company on predictable revenue models—trading guaranteed cash for a lottery ticket controlled by someone else is a poor trade. You need to structure these terms with the same rigor you applied to your product architecture.
The single biggest determinant of whether you get paid is the metric you agree to measure. Buyers love EBITDA earnouts. They will argue that EBITDA aligns incentives because it focuses on profitable growth. Do not believe them. EBITDA is an opinion; Revenue is a fact.
When you sell, you lose control of the cost structure. The buyer can load your P&L with corporate overhead, "integration costs," and shared services allocations that decimate your EBITDA margin. If they delay a key hire or cut your marketing budget to save cash elsewhere, your earnout targets become mathematically impossible. This is why 62% of earnouts in 2024 used revenue as the primary metric, compared to just 22% for EBITDA.
Time is your enemy. The longer the earnout period, the higher the probability of a "black swan" event or a strategic pivot that renders your targets obsolete. The median earnout length is now 24 months. If a buyer pushes for three or four years, they are effectively asking you to predict the macroeconomy. Fight for 12 to 18 months. If you must go longer, demand a "catch-up" provision: if you miss Year 1 but crush Year 2, you should still receive the full payout.
You must also document the "status quo" of operations. If your processes aren't documented, you have no baseline to argue that the buyer failed to support the business. A lack of documentation allows the buyer to claim that you failed to execute, rather than admitting they failed to resource the plan.
Negotiating the number is easy; negotiating the governance is where you win. To ensure your earnout actually pays out, you must insert specific protective covenants into the definitive agreement. Do not rely on a generic "commercially reasonable efforts" clause—it is toothless in court.
Before you sign the LOI, use The Acquirer’s Checklist to stress-test their intentions. Are they buying you for growth, or for cost synergies? If it's the latter, an earnout is worthless paper. The goal is to get paid for the value you built, not to subsidize the buyer's risk.
