What is an Earnout?

An earnout is an agreement between the buyer and seller of a business whereby the buyer agrees to pay the seller additional money based on the performance of the business.

How Does an Earnout Work?

Let's say Jane Smith buys a frame business from John Doe for $1 million. Jane is unsure about the neighborhood, and she only can get a loan for $700,000. She negotiates an earnout with John.

Under the agreement, Jane agrees to pay John 5% of gross sales for the next eight years. That way, if the business does more than $700,000 a year in gross sales, John will make at least $280,000 or more during that time (5% of $700,000 = $35,000 x 8 years). However, if the business does less than $700,000 a year, he will get less from the earnout.

Why Does an Earnout Matter?

Earnouts can be structured in a variety of ways, but the general idea is to encourage the sellers of businesses to be truthful about their businesses' earnings potential with buyers. They also encourage them to stick around and provide guidance to the buyer after the sale. Earnouts also help buyers feel more secure about the possibility of overpaying for a business that doesn't perform as expected.

Ask an Expert about Earnout

All of our content is verified for accuracy by Paul Tracy and our team of certified financial experts. We pride ourselves on quality, research, and transparency, and we value your feedback. Below you'll find answers to some of the most common reader questions about Earnout.

Be the first to ask a question

If you have a question about Earnout, then please ask Paul.

Ask a question
Paul Tracy
Paul Tracy

Paul has been a respected figure in the financial markets for more than two decades. Prior to starting InvestingAnswers, Paul founded and managed one of the most influential investment research firms in America, with more than 3 million monthly readers.

Verified Content You Can Trust
verified   Certified Expertsverified   5,000+ Research Pagesverified   5+ Million Users