Short answer: An earnout is deferred purchase price tied to future performance — typically 10–40% of the price, paid over two to four years against revenue or EBITDA milestones. It works in your favor when the milestones measure things you can still influence, the metric sits high on the income statement (revenue is harder to game than EBITDA), and payouts are proportional rather than all-or-nothing. The three traps to negotiate out: a buyer-controlled EBITDA denominator, missing operating covenants, and an all-or-nothing cliff.

An earnout sounds simple: sell your business now, get part of the price later if the business performs. Buyers love proposing them. Sellers sign them without reading them closely. And a few years later, one side is usually unhappy — almost always because of terms that took thirty seconds to write and nobody spent thirty minutes questioning.

I use earnouts in our own deals, so this isn't a warning against them. It's a walkthrough of how they actually work, when they genuinely help you, and the three traps that cost sellers real money.

What an earnout actually is

An earnout is deferred purchase price tied to future performance. In our world, earnouts typically cover 10–40% of the total price and pay out over two to four years, tied to revenue or EBITDA milestones.

Why do they exist? Because buyer and seller honestly disagree about the future. You believe the big customer renews and the new location works. The buyer believes it less. An earnout lets you both be right: if you're right, you get paid for it; if the buyer's caution was justified, they didn't overpay. Used honestly, it's a fairness mechanism, not a trick.

When an earnout works in your favor

An earnout is genuinely good for you when three things are true:

  1. The milestones measure things you can still influence. If you're staying on as operator or advisor, tying payments to the growth you'll personally drive is reasonable — you're betting on yourself.
  2. The metric is high in the income statement. Revenue-based earnouts are far harder to manipulate than EBITDA-based ones. Every step down the P&L adds line items the new owner controls.
  3. The math survives bad luck. Ask: if we hit ninety percent of the target, what do I get? A good earnout pays proportionally. A bad one pays zero below a cliff.

The three traps

Trap one: the moving denominator. If the earnout is tied to EBITDA and the buyer controls expenses, your target can be buried in management fees, allocated overhead, or aggressive spending charged to your business unit. Insist on a definition of EBITDA that excludes buyer-added costs — or tie the earnout to revenue instead.

Trap two: the control problem. You're being paid on performance you no longer control. What happens if the buyer cuts the sales team? Changes pricing? Merges your company into another? A well-drafted earnout includes operating covenants — commitments that the buyer will run the business in the ordinary course and won't take actions whose primary effect is dodging the earnout.

Trap three: the cliff. "You get $2M if the business hits $10M in revenue" sounds fine until the business does $9.7M and you get nothing. Cliffs create ugly incentives on both sides in the final quarter. Proportional payouts — with a floor and a stretch bonus if you like — keep everyone honest.

How we structure them at NeoNox

Our earnouts are tied to revenue or EBITDA milestones defined in the term sheet — not discovered in a definitions section on page 47. They pay proportionally, they come with ordinary-course covenants, and if performance triggers aren't met, our management fees stay on holiday too. We'd rather share the downside than argue about it.

One more thing worth knowing: an earnout is one of the levers in what we call "your price, my rules." If you want a higher headline price than the market multiple supports, an earnout is often how the gap gets bridged — you're trading certainty for upside. That's a legitimate trade. Just make it with your eyes open, with the traps above negotiated out before you sign.

The bottom line

Take the earnout seriously as real money, not a lottery ticket. Negotiate the metric, the covenants, and the curve — not just the size. And if a buyer refuses to define EBITDA precisely or won't discuss operating covenants, that tells you exactly how they plan to treat the earnout. Believe them.

If you'd like a clear-eyed read on what your business is worth and which structures actually fit it, our free first-tier assessment is a no-pressure place to start.