{"concept_id":"ALTSS-PE-023","slug":"earnout","canonical_name":"Earnout","aliases":["earn-out"],"kind":"term","authority":"industry","facets":["DTM"],"domains":["PRIVATE-EQUITY"],"display_title":"Earnout","search_aliases":["what is an earnout","earnout meaning","how do earnouts work in m&a","earnout disputes","earnout accounting contingent consideration","earnout operating covenants acceleration"],"one_sentence_definition":"An earnout is a contractual promise by a buyer to pay additional purchase price to the seller after closing if the acquired business meets agreed financial or operational targets over a defined measurement period.","plain_english":"Buyers and sellers often disagree about what a business will earn. An earnout bridges the gap: the buyer pays a fixed amount at closing and promises more later if the business reaches targets such as revenue or EBITDA. The seller gets a route to its asking price; the buyer pays the higher price only if the performance arrives.","parent_concepts":[],"child_concepts":[],"related_concepts":["purchase-price-adjustment","rollover-equity","seller-financing","letter-of-intent","adjusted-ebitda","quality-of-earnings","representations-and-warranties-insurance","fair-value"],"comparison_concepts":[],"not_the_same_as":[{"slug":"purchase-price-adjustment","distinction":"A purchase price adjustment trues up the price for cash, debt and working capital at closing; an earnout pays for performance after closing."},{"slug":"seller-financing","distinction":"A seller note is a fixed debt claim repayable whatever the business earns (subject to subordination); an earnout is contingent on targets."},{"slug":"rollover-equity","distinction":"Rolled equity gives the seller ownership whose value depends on the eventual exit; an earnout pays a defined amount if defined targets are met."}],"formula_ids":[],"worked_examples":[{"title":"Illustrative headline versus present value of an earnout ($ millions)","paragraphs":["A buyer pays 100 at closing and agrees to pay up to 20 more at the end of year 2 if cumulative EBITDA over the two years reaches a target. The seller describes the deal as \"up to 120\". Even if the target is certain to be met, 20 received in two years is worth **16.5** today at a 10% discount rate, so the most the package is worth at signing is 116.5."],"calc":{"fn":"npv","inputs":{"rate":0.1,"flows":[0,0,20]},"expected":{"npv":16.5289},"tol":0.001}},{"title":"Adding the probability of payment","paragraphs":["If the parties think there is an even chance the target is met, the expected payment is 10 and its present value at 10% is **8.3**, so the expected value of the package is about 108.3, not 120. Buyer and seller usually disagree on that probability, which is why the earnout exists, and the seller also carries the credit risk of an unsecured promise from the buyer."],"calc":{"fn":"npv","inputs":{"rate":0.1,"flows":[0,0,10]},"expected":{"npv":8.2645},"tol":0.001}}],"sections":[{"heading":"How an earnout is structured","paragraphs":["An earnout clause sets out: the metric (revenue, gross profit, EBITDA, units sold, or a non-financial milestone such as a regulatory approval or a customer contract); the measurement period, which may be one period or several, measured separately or cumulatively; the payment formula, which may be all-or-nothing at a threshold, linear between a floor and a cap, or tiered; the maximum payable; the form of payment (cash, buyer shares or a note); payment dates; and whether the buyer may set off indemnity claims against earnout payments.","The accounting definitions decide most disputes. A revenue earnout is easier to measure and harder to depress through cost allocation. An EBITDA earnout tracks value more closely but exposes the seller to the buyer's decisions on integration costs, shared overheads, transfer pricing and accounting policies. Well-drafted clauses specify the policies to be applied (often consistency with the target's historical practice), how acquisitions and disposals in the period are treated, and which buyer-imposed charges are excluded."]},{"heading":"Buyer operating covenants and acceleration","paragraphs":["After closing the buyer controls the business, and the seller's earnout depends on how it is run. Sellers ask for express covenants: run the business in the ordinary course, keep separate books, maintain an agreed budget or sales force, do not divert customers or products to other group companies. Buyers resist anything that restricts integration and prefer to retain discretion subject only to a prohibition on acting with the purpose of reducing the earnout.","Acceleration clauses make some or all of the earnout payable early on defined events: a sale of the business or of the buyer, a breach of the operating covenants, insolvency, or termination of a seller-employee without cause. How far courts will imply obligations beyond the express terms, for example a duty of good faith, depends on the governing law, which is why sellers negotiate express covenants."]},{"heading":"Why earnouts lead to disputes","paragraphs":["Earnout disputes are of two kinds. Calculation disputes concern what the metric was: accounting policies, revenue recognition timing, cost allocations, the effect of integration. Contracts typically send these to an independent accountant acting as an expert, with a fixed timetable for delivering the earnout statement, reviewing it and serving objections. Conduct disputes concern whether the buyer breached its covenants or acted to avoid the payment; these normally go to court or arbitration. The scope of the expert's role and the boundary between the two kinds of dispute are themselves frequent points of contention."]},{"heading":"Valuing an earnout","paragraphs":["A headline \"price including earnout\" overstates value. The seller should discount for time, for the probability that targets are met, and for the credit risk of the buyer, since an unsecured earnout ranks behind the buyer's lenders. Buyers make the same estimate from the other side, and the gap between their views is often why an earnout was used at all. For a private equity buyer, an earnout reduces the equity and debt needed at closing, but the obligation must be funded later; credit agreements usually address whether earnout payments are permitted and whether unpaid earnouts count as debt for covenant purposes."]},{"heading":"Accounting for an earnout","paragraphs":["Under IFRS 3 and under US GAAP (ASC Topic 805, which codified FASB Statement No. 141 (revised 2007)), an acquirer recognises an earnout payable to sellers as contingent consideration at its acquisition-date fair value, as part of the consideration transferred. Changes in that fair value caused by events after the acquisition date, such as meeting an earnings target, are not measurement-period adjustments: contingent consideration classified as equity is not remeasured, and other contingent consideration is remeasured to fair value at each reporting date, with changes recognised in profit or loss (under US GAAP, in earnings unless the arrangement is a hedging instrument whose changes are recognised in other comprehensive income). Under both frameworks, a contingent payment that is automatically forfeited if the seller's employment ends is remuneration for post-combination services, not purchase consideration. A private fund that sells a company and holds an earnout receivable measures it at fair value in its NAV under its valuation policy, with fair value defined as an exit price: what a market participant would pay for the receivable on the measurement date."]},{"heading":"Earnouts in private equity transactions","paragraphs":["Sponsors use earnouts as buyers mainly in founder-owned and growth businesses, where the seller's forecast is hard to verify, alongside [rollover equity](/glossary/rollover-equity) and [seller financing](/glossary/seller-financing). As sellers, funds tend to avoid earnouts: contingent proceeds delay [DPI](/glossary/dpi), keep an asset to value in the fund after exit and can hold up wind-down. Earnouts also interact with the [purchase price adjustment](/glossary/purchase-price-adjustment): the adjustment trues up the closing balance sheet, while the earnout pays for performance after closing, and the two should not count the same item twice."]}],"classification_rules":[],"calculation_rules":[],"common_mistakes":["Quoting the price including the maximum earnout as the transaction value.","Defining the earnout metric by reference to generally accepted accounting principles (GAAP) without specifying accounting policies, cost allocations and the treatment of buyer-imposed charges.","Ignoring the seller's credit exposure: an unsecured earnout ranks behind the buyer's lenders.","Assuming the buyer must run the business to maximise the earnout. Without express covenants, its obligations may be narrow."],"edge_cases":["Under IFRS 3 and US GAAP, earnout payments that are automatically forfeited if the seller's employment ends are accounted for as compensation for post-combination services rather than as purchase price; their tax treatment depends on the jurisdiction.","If the buyer sells the acquired business during the measurement period, the result depends on the acceleration and assignment provisions.","An earnout payable in the buyer's shares adds share-price risk for the seller and, for a listed buyer, securities-law considerations.","For a fund that has sold a company, an earnout receivable is an asset that must be valued each quarter and can delay final distributions."],"external_standard_mappings":[],"source_ids":["SRC-EU-REG-2023-1803","SRC-IPEV-2025","SRC-US-FASB-FAS-141R"],"citations":[{"source_id":"SRC-IPEV-2025","pinpoint":"Section I 1.1; Section III 'Orderly Transaction', 'Market Participants'","supports":"Fair value as the exit price between market participants at the measurement date, the basis on which a fund measures an earnout receivable","source":{"source_id":"SRC-IPEV-2025","title":"International Private Equity and Venture Capital Valuation Guidelines (2025 edition)","authors":"IPEV Board","publisher":"IPEV","document_type":"standard","url":"https://www.privateequityvaluation.com/Portals/0/Documents/Guidelines/2025%20IPEV%20Valuation%20Guidelines.pdf","year":2025,"publication_date":"Published 11 December 2025; in effect for quarterly reporting periods beginning on or after 1 April 2026; early adoption encouraged","jurisdiction":"intl","status":"Current; supersedes the December 2022 edition","last_verified":"2026-10-01"}},{"source_id":"SRC-EU-REG-2023-1803","pinpoint":"Annex, IFRS 3 paras. 39, 58, B55(a)","supports":"IFRS 3: contingent consideration recognised at acquisition-date fair value; subsequent remeasurement of non-equity contingent consideration through profit or loss; payments automatically forfeited on termination of employment are remuneration","source":{"source_id":"SRC-EU-REG-2023-1803","title":"Commission Regulation (EU) 2023/1803 adopting international accounting standards (consolidated IFRS text incl. IFRS 3, IFRS 13, IFRS 16)","publisher":"European Commission (EUR-Lex)","document_type":"regulation","url":"https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX:32023R1803","publication_date":"13 August 2023; OJ L 237, 26.9.2023","jurisdiction":"EU; INTL","status":"in force","last_verified":"2026-10-02"}},{"source_id":"SRC-US-FASB-FAS-141R","pinpoint":"Paras. 41, 65, A87(a) (codified in ASC Topic 805)","supports":"US GAAP: contingent consideration at acquisition-date fair value; liability/asset-classified contingent consideration remeasured through earnings; payments automatically forfeited on termination of employment are compensation","source":{"source_id":"SRC-US-FASB-FAS-141R","title":"FASB Statement No. 141 (revised 2007), Business Combinations","publisher":"Financial Accounting Standards Board","document_type":"standard","url":"https://storage.fasb.org/fas141r.pdf","publication_date":"December 2007; codified in FASB ASC Topic 805","jurisdiction":"US","status":"superseded as a document by the Codification (requirements carried into ASC Topic 805)","last_verified":"2026-10-02"}}],"faq":[{"q":"Is an earnout part of the purchase price?","a":"Contractually, yes: it is contingent purchase price. For accounting under IFRS 3 and US GAAP (ASC Topic 805), the acquirer records it at acquisition-date fair value, but a payment that is automatically forfeited if the seller's employment ends is treated as compensation for post-combination services instead."},{"q":"Who decides an earnout dispute?","a":"Usually the agreement sends disputes about the calculation to an independent accountant acting as expert and leaves alleged breaches of operating covenants to a court or arbitration. The contract defines the boundary."}],"seo":{},"first_published":null,"last_reviewed":"2026-10-02","last_modified":"2026-10-02","content_version":"2.0.0","url":"https://altss.com/glossary/earnout","json_url":"https://altss.com/reference/concepts/earnout.json","title":"Earnout","formulas":[],"sources":[{"source_id":"SRC-EU-REG-2023-1803","title":"Commission Regulation (EU) 2023/1803 adopting international accounting standards (consolidated IFRS text incl. IFRS 3, IFRS 13, IFRS 16)","publisher":"European Commission (EUR-Lex)","document_type":"regulation","url":"https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX:32023R1803","publication_date":"13 August 2023; OJ L 237, 26.9.2023","jurisdiction":"EU; INTL","status":"in force","last_verified":"2026-10-02"},{"source_id":"SRC-IPEV-2025","title":"International Private Equity and Venture Capital Valuation Guidelines (2025 edition)","authors":"IPEV Board","publisher":"IPEV","document_type":"standard","url":"https://www.privateequityvaluation.com/Portals/0/Documents/Guidelines/2025%20IPEV%20Valuation%20Guidelines.pdf","year":2025,"publication_date":"Published 11 December 2025; in effect for quarterly reporting periods beginning on or after 1 April 2026; early adoption encouraged","jurisdiction":"intl","status":"Current; supersedes the December 2022 edition","last_verified":"2026-10-01"},{"source_id":"SRC-US-FASB-FAS-141R","title":"FASB Statement No. 141 (revised 2007), Business Combinations","publisher":"Financial Accounting Standards Board","document_type":"standard","url":"https://storage.fasb.org/fas141r.pdf","publication_date":"December 2007; codified in FASB ASC Topic 805","jurisdiction":"US","status":"superseded as a document by the Codification (requirements carried into ASC Topic 805)","last_verified":"2026-10-02"}]}