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Definition of 'Earnout'
A contractual provision stating that the seller of a business is to obtain additional future compensation based on the business achieving certain future financial goals.
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Investopedia explains 'Earnout'
The financial goals are usually stated as a percentage of gross sales or earnings.
Say an entrepreneur selling a business is asking $2,000,000 based on projected earnings, but the buyer is willing to pay only $1,000,000 based on historical performance. An earnout provision structures the deal so that the entrepreneur receives more than the buyer's offer only if the business achieves a certain level of earnings. The exact numbers would depend upon the business, but in this example a simplified provision might set the purchase price at $1,000,000 plus 5% of gross sales over the next three years. The earnout thereby helps eliminate uncertainty for the buyer.
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