Earnouts. How They Work and How Founders Can Structure Them to Their Advantage
Earnouts are sometimes considered a dirty word in the world of mergers and acquisitions. Truth be told, we often avoid them in our deal structures mainly due to the added complexity. However, sometimes they just make sense—especially in technology M&A. Buyers and founders can be fully aligned on the same long-term vision of a company, but each may see its current valuation differently due to misalignment on the timing and/or probability of attaining certain future outcomes. Buyers may put much less value on the future revenue, earnings, and other performance indicators of a company beyond certain amounts, while founders may have a great deal more conviction on those future achievements and therefore place more value on them.
This gap between present performance and future potential can make it difficult to reach an agreement on valuation. Earnouts offer a practical way to bridge or bring both sides together. They allow acquirers to manage uncertainty while giving founders the opportunity to participate in the value their companies create after the transaction closes. Although earnouts can seem technical or difficult to navigate, they become far more approachable once the underlying mechanics are understood. For founders who prepare carefully and negotiate thoughtfully, earnouts can be a valuable part of an overall deal strategy.
What Is an Earnout?
An earnout is a contractual agreement in which a portion of the purchase price is paid over time if the acquired business achieves specific performance targets. These targets usually relate to revenue, EBITDA, net retention, product milestones, or other measurable metrics that reflect the financial and operational health of the business. Instead of paying the full price at closing, an acquirer pays an initial amount and then pays additional amounts if the company performs as the founder expected.
This structure gives buyers comfort that they are not overpaying for projected results. It also gives founders an opportunity to capture additional value by continuing to influence the company’s performance during the earnout period.
Why Acquirers Use Earnouts
Acquirers use earnouts for several practical reasons:
Earnouts reduce valuation risk. When a company’s future growth is uncertain or when projections appear optimistic, buyers prefer to tie part of the valuation to post-closing outcomes.
Earnouts help keep key leaders invested in the transition. Founders and executives often have unique knowledge and relationships that drive the company’s success, so an earnout encourages continued engagement.
Earnouts can be a strategic way to manage cash. Rather than allocating all capital at closing, a buyer can match part of the purchase price to future financial performance.
Earnouts are especially common in technology markets where revenue quality, product adoption, and customer retention vary widely. As a result, earnouts provide acquirers with a practical method for managing uncertainty while preserving the ability to offer sellers a competitive price.
How Earnouts Are Structured
Although each earnout is unique, most structures include a measurement period, performance targets, payment timing, and operational guidelines.
Measurement Period: Typically lasts between one and three years. Buyers prefer longer timeframes to smooth out fluctuations, while founders often push for shorter periods that reflect momentum at the time of sale.
Performance Targets: Must be clear and objectively measurable. Top-line revenue and gross profit are common because they are difficult to manipulate. EBITDA-based earnouts require careful definition of allowable adjustments and expenses. Some technology acquirers also use milestones such as product releases, contract wins, or platform integrations.
Payment Timing: Some earnouts pay annually based on performance, while others pay at the end of the measurement period. Founders usually prefer annual payouts because they reduce the risk that performance in the final year diminishes overall results.
Operational Guidelines: Define how decisions will be made after closing to protect the seller from unintended consequences, such as expense cuts that depress revenue or strategic shifts that hinder growth. The more the acquirer integrates the business into its own operations, the more important these protections become.
How Founders Can Structure Earnouts to Their Advantage
When approached correctly, an earnout can create meaningful upside for founders. The key is to structure terms that are realistic, well-defined, and aligned with the acquirer’s operating plans.
Founders can start by negotiating metrics they can influence. If the company’s revenue depends heavily on sales execution, founders may request revenue-based targets, as long as revenue is very clearly defined. If the buyer plans to integrate the product into a larger platform, milestones tied to integration timelines may be more appropriate. The goal is to avoid targets that rely on decisions outside of the founders’ control.
Next, founders should ensure that targets reflect reasonable baseline performance. Historical data, pipeline visibility, seasonality, and expected investment levels should all inform the targets. Overly aggressive assumptions can reduce the likelihood of payout and undermine the purpose of the earnout.
Clear operating covenants are another essential element. Founders can negotiate protections that require the buyer to maintain adequate staffing, sales support, product investment, or marketing activity. These guardrails help ensure that operational changes do not inadvertently reduce the ability to meet agreed-upon targets.
Clearly defining the earnout metrics and ensuring transparency during the earnout period are equally important. Defining the earnout metrics is an essential step to avoid conflicts down the road. If the earnout is revenue, then it’s typically based on GAAP accounting rules. However, if it is ARR or EBITDA, both non-GAAP concepts, then it is essential to clearly define what contractually is included in total ARR and what specific line items are included and not included in EBITDA. Transparency throughout the earnout period is also critical. This includes regular reporting, access to financials, and a defined process for reviewing performance. A well-designed governance structure reduces misunderstandings and supports a smoother post-closing relationship.
Why Founders Benefit from Hiring Peak Technology Partners
Earnouts can create significant value, but only when founders understand the variables that influence their success. This is an area where experienced investment bankers can make a meaningful difference. Peak Technology Partners specializes in advising founder-led and bootstrapped technology companies, and the firm regularly negotiates earnout structures across a wide range of M&A transactions.
PEAK helps founders evaluate whether an earnout is appropriate, model potential outcomes, and negotiate terms that reflect achievable performance. The firm also understands how strategic buyers and private equity groups view earnouts, which allows founders to enter negotiations with a clear picture of market norms. Beyond technical modeling, PEAK guides founders through the operational and governance protections that are essential for maximizing the likelihood of payout.
For many founders, an earnout may represent a significant portion of their ultimate proceeds. Having a disciplined advisor who understands the nuances of deal structure, valuation, and negotiation can greatly improve the probability of a favorable result. Peak Technology Partners provides this level of support and helps founders navigate complex deal dynamics with confidence.
Conclusion
Earnouts are common in technology M&A because they provide a balanced way for buyers and sellers to reach agreement on valuation. With the right structure, earnouts can protect buyers from downside risk while giving founders a meaningful opportunity to capture additional value. Founders who understand how earnouts function, how they are measured, and how they can be structured and optimized through negotiation will be better positioned to use them to their advantage. Partnering with an experienced advisor such as Peak Technology Partners further strengthens that position by ensuring that earnouts are well-designed, well-negotiated, and strategically aligned with long-term success.