Define: Earnout Agreement

An earnout agreement is a contractual arrangement between a buyer and seller in a business acquisition, where a portion of the purchase price is contingent upon the future performance of the acquired business.

Under an earnout agreement, the seller receives a portion of the purchase price upfront, and the remaining amount is paid based on the achievement of certain predetermined financial targets or milestones by the acquired business over a specified period.

Earnout agreements can be beneficial for both buyers and sellers. Buyers can mitigate risks by tying a portion of the purchase price to the future performance of the business, while sellers can potentially receive a higher overall purchase price if the business performs well.

The specific factors considered in determining earnout payments can vary depending on the agreement, but they often include financial metrics such as revenue, profitability, or customer retention.

To prevent manipulation, earnout agreements usually include provisions that require the buyer to act in good faith and not take actions that would intentionally harm the business’s performance to avoid paying earnout amounts. However, disputes may arise if there are disagreements over the buyer’s actions.

While sellers may have an interest in maximizing earnout payments, they are generally restricted from taking actions that would artificially inflate the business’s performance. The agreement may include provisions to prevent such manipulation.

If the business fails to meet the earnout targets, the buyer is not obligated to pay the additional earnout amount. The seller would only receive the portion of the purchase price that was paid upfront.

Yes, earnout agreements are typically negotiable. Both parties can negotiate the specific terms, including the earnout period, targets, and any other relevant provisions.

Earnout agreements are legally enforceable if they meet the necessary requirements for a valid contract, such as mutual consent, consideration, and a clear and unambiguous agreement.

Before entering into an earnout agreement, it is important to carefully consider the terms and conditions, including the earnout period, targets, and any potential risks or uncertainties that may affect the business’s ability to achieve the earnout targets. Consulting with a legal professional experienced in business acquisitions is advisable.