M&A Market: Look Before You Leap – A Guide to Earnouts

Before agreeing to an earnout as a seller, it’s important to understand the broader context of how they work and their potential pitfalls. Here are some key insights:

Earnouts Aren’t as Common as You Think

Despite what buyers might suggest, earnouts aren’t as prevalent in in-demand industries, especially those with consistent and recurring revenue that present rollup opportunities. In fact, according to the 2024 SRS Acquiom Deal Terms Study, only 1 in 5 non-life sciences deals in 2023 involved an earnout.

Earnouts Rarely Pay in Full

The same study revealed that earnouts pay out less than 50% of the time. While that might be acceptable if the earnout is based on aggressive growth targets that weren't priced in at closing, it’s a major red flag if the earnout is tied to maintaining steady performance—especially if it’s crucial to reaching a fair purchase price. Sellers should be prepared to live with the purchase price minus the earnout if they agree to such a structure.

Revenue-Based Earnouts Are More Common

Earnouts tied to top-line metrics like revenue are three times more common than those tied to mid-line metrics such as EBITDA. Since revenue-based metrics are less affected by post-closing expenditures, they tend to be more favorable to sellers.

Earnouts Make Up About 30% of Purchase Price

Over the past few years, the median earnout potential has hovered around 30% of the total purchase price.

Most Earnouts Last Less Than Two Years

Over 60% of earnouts have a term of less than two years. The longer the earnout period, the more variables come into play, increasing the risk for sellers.

Bottom Line: Earnouts can be a useful tool, especially when they help bridge a valuation gap. However, sellers need to remember that they’re not as common as they might seem—and they often don’t pay out in full. It’s essential to be comfortable with the closing purchase price without the earnout before agreeing to one.