The short answer: An earnout splits the price into a fixed payment at closing and a contingent payment paid later only if the business hits defined targets (revenue, EBITDA, or a milestone). Most run 1 to 3 years, measured quarterly or annually. They bridge a valuation gap, but roughly 18%, 22% end in dispute, usually over how the metric was calculated. Note: SBA 7(a) rules make earnouts hard, so many buyers use a standby seller note to defer price instead.
What an earnout is
Sometimes the seller believes the business is worth more than you do, usually because they're counting on future growth you can't see yet. An earnout resolves it by tying part of the price to whether that future actually shows up. You pay a solid amount at closing, then additional payments only if the business hits agreed numbers.
It shifts risk fairly: if the seller's optimism is right, they get paid; if it isn't, you don't overpay. That's why earnouts appear most in deals with uncertain forecasts, customer concentration, or a founder whose role is hard to replace.
An earnout is a bet the seller offers you: "Pay me the upside only if the upside is real."
How the contingent payment is structured
The trigger can take several forms, and the choice drives everything about how the earnout behaves:
- Percentage of revenue above a floor, simple, but rewards top-line even if margins fall.
- Multiple of EBITDA within a range, aligns to profit, but invites disputes over how EBITDA is defined.
- Binary milestone, a flat sum if a specific event happens (contract renewal, launch, license).
- Sliding scale, graduated payouts across a band of outcomes, softening the all-or-nothing cliff.
Worked example: earnout in the price
A seller wants $1,200,000; you'll pay $1,000,000 based on today's numbers. You bridge the $200,000 with a two-year earnout tied to EBITDA:
| Component | Amount | Trigger | When paid |
|---|---|---|---|
| Cash at closing | $1,000,000 | None, fixed | At close |
| Earnout, year 1 | $100,000 | EBITDA ≥ $250K | After year 1 audit |
| Earnout, year 2 | $100,000 | EBITDA ≥ $260K | After year 2 audit |
| Max total price | $1,200,000 | Only if both targets hit |
You only pay the full $1.2M if the business actually earns it. If year-1 EBITDA lands at $240K, that $100,000 isn't owed, you paid a price that matched reality. The closing $1,000,000 is the piece you'd typically finance with an SBA loan and equity; check what that base supports with the max purchase price calculator and SBA loan calculator.
Where earnouts go wrong
Roughly 1 in 5 ends in dispute, almost always over how the metric was measured. After closing, you control the books, so the seller fears you'll shift costs, cut marketing, or reallocate revenue to miss the target. Kill that fear with airtight definitions.
Clauses that prevent the fight
- Locked accounting method: define exactly how EBITDA/revenue is calculated, with a worked sample schedule attached.
- Operating covenants: commit to run the business normally during the period, no starving marketing or headcount to game the number.
- Independent accountant: name a neutral firm to resolve calculation disputes, avoiding litigation.
- Acceleration on sale: if you resell or change control mid-earnout, the remaining amount becomes due.
- Seller access: give the seller audit rights to the relevant figures so trust is verifiable.
SBA deals: use a standby note instead
Because the SBA restricts contingent, performance-based pricing, earnouts are difficult inside a 7(a) loan. If you're financing with the SBA and want to defer price, a seller note on full standby gets you most of the same benefit with none of the SBA friction.
Deferring part of the price?
A standby seller note is often the cleaner tool, start from a term sheet that works with the SBA.
Frequently asked questions
It splits the price into a fixed amount paid at closing and a contingent amount paid later only if the business hits defined targets like revenue or EBITDA thresholds. It bridges a gap when buyer and seller disagree about future performance.
Most run one to three years after closing, with milestones measured quarterly or annually. The payment is often a percentage of revenue above a floor, a multiple of EBITDA in a range, or a flat sum tied to a milestone.
Roughly 18%, 22% per SRS Acquiom data, usually over how the performance metric was calculated. Clear definitions, an agreed accounting method, and a named independent accountant to resolve disputes cut the risk.
It's difficult. SBA 7(a) rules restrict contingent, performance-based pricing, so earnouts are hard inside an SBA deal. Many buyers use a full-standby seller note to defer price instead. See seller financing.
Sources
- Earnout structures, dispute rates, and protective covenants, Davis Wright Tremaine (2026), Morgan & Westfield, and SRS Acquiom earnout data.
- SBA limits on contingent pricing, SOP 50 10 8 summaries; sba.gov 7(a) program (2025 to 2026).
