Earnouts Explained: How Buyers and Sellers Split Risk After Closing

A structure where part of the purchase price is paid after closing, contingent on the business hitting specific milestones. Unlike seller financing, which requires fixed monthly payments regardless of performance, an earnout only pays out under agreed conditions — which shifts some risk from buyer to seller.

Why it matters: Earnouts let a buyer bridge a gap in confidence about the business's future performance without walking away from the deal — useful when there's a real risk the seller can help manage (like customer concentration) but can't fully guarantee. For a seller, agreeing to an earnout means part of the "sale price" isn't guaranteed money — it's contingent on factors that may be partly outside their control once they've handed over the keys, which is exactly why earnout terms generate more disputes after closing than almost any other deal term. The contract language is what protects both sides: a poorly specified earnout ("if revenue stays strong") invites disagreement, while one tied to a specific, measurable trigger (a named customer's order volume, a defined revenue threshold) is much easier to enforce. For a business with one dominant customer or contract, an earnout is often the mechanism that makes an otherwise difficult sale possible at all.

Example: A machine shop generates 60% of revenue from one aerospace customer with no long-term contract. A strategic buyer offers 70% of the price at closing and the remaining 30% paid over three annual installments, contingent on that customer's orders staying above 80% of the pre-sale three-year average. If the customer cuts orders in half in year two, the seller's third-year earnout payment is reduced or eliminated.

Earnouts are typically paid annually over two to three years; buyers rarely accept terms stretching past three years, since the point is a short, defined transition of risk.

Contract language needs to spell out every what-if scenario — a buyer-caused drop in orders, an economy-caused drop, normal year-to-year fluctuation. A business broker's role is to make sure both sides think through these scenarios and negotiate clear terms before attorneys formalize the language.

Related terms: Seller Financing, Customer Concentration, Deal Structure, Second Bite of the Apple