An earnout is purchase consideration paid after closing if the business meets conditions defined in the transaction agreement.
Definition
An earnout makes some of a business's purchase consideration contingent on meeting agreed conditions after closing. A transaction agreement defines the measures, measurement period, calculation method, payment timing, and treatment of events that may affect results. Possible measures include revenue, earnings, or client retention, but the parties determine what applies. For an engineering firm owner, an earnout can leave part of the price dependent on business performance after ownership and control have changed. Firms and transaction parties may define financial measures differently, including which costs, clients, or business units count. An earnout is not guaranteed payment at closing, and it is not necessarily the same as seller financing, where a seller allows payment of an agreed amount over time. The agreement's definitions and operating provisions determine whether targets are met and how disputes are handled. See ACEC for resources for engineering firm owners.
How owners use it
- Review the target measure, calculation rules, timing, and operating assumptions in an earnout provision.
- Track the records needed to calculate performance under the agreement after closing.
- If the agreement sets a $1,000,000 target and qualifying results are $900,000, the shortfall is $1,000,000 - $900,000 = $100,000.
