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An earnout agreement is the part of an M&A deal that makes some of the purchase price depend on how the business performs after closing. In 2024, 22% of private-target deals outside life sciences had one, and the median earnout was worth 31% of the closing payment, according to SRS Acquiom.
For a buyer, an earnout defers part of the price until the seller’s forecast is proven. For a seller, it is a chance at a higher price, but data from 2025 deals shows sellers collect only about 20% of potential earnout dollars on average. The drafting decides how much of that money you actually see.
This guide covers the clauses an earnout agreement needs, how payments are calculated, how earnouts are accounted for and taxed, and how to avoid disputes.
An earnout (also written earn-out) is contingent consideration: extra purchase price paid only if agreed targets are hit in a set period after closing. It sits in the share purchase agreement (SPA), usually as a schedule, and is first agreed in outline at the LOI stage.
Earnouts are most common in these situations:
Public-company deals use a listed equivalent, the contingent value right. See earn-out vs contingent value right for how the two compare.
SRS Acquiom’s 2025 Deal Terms Study covers more than 2,200 private-target acquisitions. These are its figures for deals outside life sciences:
| Term | 2023 deals | 2024 deals |
|---|---|---|
| Deals with an earnout | 33% | 22% |
| Median earnout as % of closing payment | 34% | 31% |
| Earnout period longer than one year | 80% | 76% |
| Revenue used as a metric | 95% | 65% |
| Earnings or EBITDA used as a metric | 23% | 13% |
| Acceleration on a change of control | 23% | 39% |
Earnouts can use more than one metric, so the metric rows can add up to more than 100%. SRS Acquiom’s snapshot of 2025 deals shows prevalence rising again to 24%, well above the historical norm of about 15%.
A workable earnout schedule answers every question that could decide the payment. Use this as a checklist:
Earnouts sit alongside other price tools such as escrows, rollover equity and reps and warranties insurance, so draft set-off and escrow terms together.
The payment formula is where most of the value is won or lost. These are the common structures:
Worked example (illustrative numbers): a buyer pays $40m at closing plus up to $10m based on year-two revenue. The threshold is $20m and the cap is $25m, paid on a linear scale. Year-two revenue comes in at $23m.
Under a cliff structure with the target at $25m, the same result would pay $0. Sellers should push for linear or tiered payouts and a catch-up, and buyers should resist uncapped percentage-of-excess terms.
Treat the headline earnout as a maximum. Value it as a probability-weighted expected payment, then discount it for time and the buyer’s credit risk.
Using the example above, assume three outcomes for year-two revenue:
So a “$50m deal” is worth about $44.5m to the seller today. Valuers use the same logic for the accounting fair value, often with a Monte Carlo simulation for revenue or EBITDA targets. The real-world data supports a cautious view: in 2025 deals where any earnout was paid, sellers received about 50 cents per dollar of potential earnout.
The first question is whether the earnout is purchase price or pay for future work. Under US GAAP (ASC 805), continuing employment is a strong indicator. If employee-sellers forfeit their earnout when they leave, it is usually treated as compensation and expensed after closing. If all sellers are paid pro rata with no service condition, it is usually purchase consideration.
Earnouts treated as purchase consideration follow these rules:
IFRS 3 works the same way in practice. Fair value at acquisition, no remeasurement for equity-classified amounts, and fair value through profit or loss for financial liabilities.
This creates an odd result for buyers. In the example, if the business outperforms and the earnout liability rises from $4.5m to $8m, the buyer books a $3.5m expense. Good performance by the acquired business reduces reported earnings, which is why buyers model earnout fair value changes in their forecasts.
In the UK, sellers want an earnout taxed as capital gain on the sale of their shares. HMRC can tax it as employment income if it rewards services, for example where leavers forfeit their share or the targets are personal.
A second UK issue is timing. Under the Marren v Ingles principle, the right to an unascertainable earnout is a separate asset, so sellers can owe capital gains tax on its estimated value at completion, before any cash arrives. Taking the earnout in loan notes can defer this. Get tax advice on the structure before heads of terms are signed.
Earnout disputes usually come from vague definitions or from the buyer running the business in a way that misses the target. The Johnson & Johnson acquisition of Auris Health shows the stakes.
J&J paid $5.75bn upfront with up to $2.35bn in milestone earnouts, and none of the milestones were met. The Delaware Court of Chancery awarded the sellers more than $1bn, and in January 2026 the Delaware Supreme Court upheld the finding that J&J breached its commercially reasonable efforts obligation.
To reduce dispute risk, both sides should:
If you want to practise building earnout scenarios into a full deal model, the Wall Street Oasis courses cover M&A and merger modelling.
Most earnouts run for more than one year, usually two to three. In 2024, 76% of private-target deals outside life sciences had an earnout period longer than one year, according to SRS Acquiom. Milestone earnouts in life sciences can run longer because regulatory approvals take time.
The median earnout in 2024 was worth 31% of the closing payment, based on SRS Acquiom data for deals outside life sciences. Smaller deals, with upfront payments of $50m or less, tend to put a larger share of total value into the earnout.
Revenue is used far more often, in 65% of 2024 earnouts against 13% for EBITDA. Sellers prefer revenue because buyer cost decisions after closing cannot reduce it. Buyers prefer EBITDA because it ties the payment to profit, but it needs tight definitions of costs and allocations.
The buyer records the earnout at fair value at closing as part of the purchase price. A cash earnout is normally a liability, remeasured each reporting period with changes in the income statement. An earnout that is really pay for continued employment is expensed as compensation instead.
An earnout agreement lets a buyer and seller close a valuation gap by tying part of the price, a median 31% of the closing payment, to post-closing results. Sellers collect only part of that on average, so value the earnout as a probability-weighted payment and negotiate the definitions, formula, buyer covenants and acceleration terms as hard as the headline price.
P.S. To see how an earnout changes the price, funding and returns of a deal, try the Merger Financial Model. Our Premium Resources have more tools you may find useful, and the Private Equity Bros newsletter brings you weekly finance updates and the latest financial reports.
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