Earnouts are becoming increasingly popular in M&A transactions, especially as they can bring together buyers and sellers who have disparate valuation expectations. When a seller is unsatisfied with the buyer’s immediate upfront offering, they can agree to an earnout, which would provide them with a portion of the sale price in future payments, contingent upon certain performance milestones.

When an earnout is included in a purchase agreement, the buyer pays an agreed-upon price upfront, with a portion of the price being deferred until particular performance targets are met. The earnout specifies the goals and time period during which the goals must be met. It also outlines payment terms for the deferred portion of the sale price.

The performance-based payment structure that is part of an earnout gives sellers more certainty than traditional methods, because a portion of the sale price is earned only when an approved milestones or targets is met. Meanwhile, the buyer reduces their risk by not having to pay the full sale price at the outset. If an earnout is properly structured, both buyer and seller can benefit from the transaction.

Earnouts should be carefully drafted with attention to defining and measuring performance milestones, as well as accounting methodology. Additionally, the earnout should also define and set reasonable expectations, as it may incorporate multiple levels and milestones. The overall success or failure of the earnout hinges on the clarity of the agreement, and the diligence of both buyer and seller in measuring success or failure and allocating payments according.

In conclusion, an earnout is an effective way to bridge the gap between buyer, who requires a good deal and seller, who doesn’t want to part with their business. When properly structured, earnouts can provide a win-win situation for both buyers and sellers, as the seller can receive additional compensation for meeting performance goals and the buyer is not locked in to paying the full purchase price upfront.