M&A Concepts

Earnout
(M&A)

Contingent purchase price that depends on post-close performance — how earnouts bridge valuation gaps and retain key people.

4 min read Concept Guide

What Is It?

An earnout is a portion of the purchase price that the seller receives later, contingent on the acquired company hitting performance targets after the deal closes.

Instead of paying the full price at closing, the buyer says: "We'll pay $30M now and up to $10M more over the next 2-3 years if the business hits these revenue/EBITDA targets."

Why Buyers Use Them

Bridge the valuation gap: Seller thinks the company is worth $40M, buyer thinks $30M. An earnout lets them split the difference—seller gets $40M if they're right, buyer only pays $40M if performance proves it.
Retain key people: If the earnout depends on performance, the seller (often the founder/CEO) has a financial incentive to stay and keep the business running.
Reduce risk: If a major recompete is pending, the buyer doesn't want to pay full price until that contract is re-won.

How They Typically Work in GovCon

Measurement period: Usually 1-3 years post-close
Metric: Most commonly EBITDA or gross profit. Revenue-based earnouts are less common because revenue can be inflated with low-margin pass-throughs.
Threshold: Minimum performance level to trigger any payout
Cap: Maximum earnout payment regardless of performance
Payment timing: Usually paid within 90-120 days after the measurement year ends (the "true-up" period while financials are finalized)

Example

Component	Amount
Upfront cash at close	$30M
Earnout Year 1	Up to $5M if EBITDA >= $6M
Earnout Year 2	Up to $5M if EBITDA >= $6.5M
Maximum total	$40M

If Year 1 EBITDA comes in at $5.5M (below threshold), the seller gets $0 for that year. If Year 2 hits $7M, they get the full $5M.

What Can Go Wrong

Integration disruption: Buyer changes the business (merges teams, adjusts indirect rates, moves offices), causing EBITDA to drop. Seller argues the miss isn't their fault.
Accounting disputes: How is EBITDA calculated? Are buyer's corporate allocations included? These details must be defined precisely in the purchase agreement.
Key person departure: If the founder leaves during the earnout period, performance often suffers.

Where This Appears in Arcvue

M&A Module → Deal Setup—configure earnout terms (threshold, cap, measurement years)
M&A Module → Deal Summary—projects earnout payments based on forecasted performance
M&A Module → Financing—earnout payments appear in the cash flow projection

The Operator's View

Earnouts are probably the most heavily litigated aspect of post-closing M&A disputes. The construct is inherently combustible: the performance of a business that is no longer under the seller’s control determines whether additional proceeds get paid. Depending on the deal structure and the seller’s financial situation, those proceeds might feel like icing on the cake—or they might feel like a very real reduction to the purchase price they thought they were getting.

The instinct to simplify is understandable. Tie the earnout to something binary—a contract award, for example—and you sidestep the ambiguity. That was my thinking early in my investment banking career, when I knew enough to be dangerous but only enough to be dangerous. I learned quickly how much daylight can exist between an award and what was modeled: scope changes, period of performance differences, bid protests, or the uncomfortable reality that the seller may control the proposal while the buyer controls the price.

Since then, I’ve structured every earnout around legally well-defined gross profit. Not revenue—buyers have legitimate concerns about low-margin, low-quality revenue inflating a payout. Not EBITDA—sellers have legitimate concerns about buyers loading up indirect spend to suppress the number. Gross profit meets both parties in the middle. It isn’t immune from disputes, but it directly answers the question the earnout is supposed to be asking: did this business actually perform?