The Funnel, Ep. 12: What's An 'Earn-Out' and Should You Agree?
Once you reach the bottom of the funnel, the conversation shifts from whether you’ll sell to how the deal will actually be structured. This is where specific deal terms start to matter. One of the most common and most misunderstood of those terms is the earn-out. It often shows up in a Letter of Intent and can look attractive on the surface. In reality, it’s one of the most important areas where founders need to slow down, understand the tradeoffs, and be clear-eyed about risk.
This episode explains what an earn-out really is, why buyers propose them, and how to think about whether agreeing to one makes sense in your situation.
An earn-out is a portion of the purchase price that is paid after closing, based on future performance. Instead of receiving all proceeds at close, part of the consideration is contingent on hitting specific milestones over a defined period—often one to three years. Those milestones are usually tied to financial metrics such as revenue, EBITDA, or growth targets. In practice, this means a buyer is asking you to accept future risk in exchange for the possibility of additional upside. On paper, an earn-out can make a deal look larger. In reality, it often shifts risk away from the buyer and onto the seller.
Why Earn-Outs Are Risky for Founders
The core issue with earn-outs is control. Once a transaction closes, the buyer typically controls the business. That means they control:
Spending decisions
Hiring plans
Investment timing
Growth strategy
Profitability
If your earn-out is tied to profitability, EBITDA, or margins, your ability to influence the outcome may be limited. Even well-intentioned decisions—such as hiring salespeople, upgrading systems, or investing for long-term growth—can reduce short-term profitability and make earn-out targets difficult or impossible to hit.
Importantly, earn-outs don’t usually fail because buyers act in bad faith. They fail because incentives change after closing.
How Often Earn-Outs Actually Pay Out
In practice, earn-outs are paid far less frequently than founders expect. Experienced M&A attorneys who have worked on hundreds of transactions often estimate that only about 20% of earn-outs fully pay out. Many partially pay. Many don’t pay at all. This doesn’t mean earn-outs are inherently unfair. It does mean they are statistically unlikely to deliver the upside sellers imagine when signing.
There are limited scenarios where an earn-out can be reasonable:
You are satisfied with the cash at close and view the earn-out as true upside, not required value
The earn-out is based on revenue, not profitability
The performance metrics are narrow, measurable, and within your control
The earn-out period is short
Expectations and operating authority are clearly defined
In these cases, an earn-out functions more like a bonus than deferred purchase price.
Better Alternatives to Earn-Outs
Often, earn-outs are proposed because buyers and sellers disagree on valuation. In many cases, there are other ways to bridge that gap, including:
Higher cash at close with less contingent consideration
Adjustments to retained equity
Structured seller notes
Shorter-term performance incentives tied to specific initiatives
These alternatives can preserve upside without exposing founders to long periods of uncontrollable risk.
How Candor Advisors Helps Founders Navigate Earn-Outs
Earn-outs are one of the most consequential deal terms in a business sale—not because they’re common, but because they quietly shift risk after the deal is “done.” Candor Advisors helps founders evaluate earn-outs in the context of the full transaction, not just headline value. That includes stress-testing assumptions, understanding who controls outcomes post-close, and identifying alternative structures that better align incentives. An earn-out isn’t automatically wrong—but it should never be accepted casually. With the right guidance, founders can decide whether it’s a calculated upside opportunity or a risk better avoided as they move toward closing.
