What Is an Earnout When Selling a Business? Examples, Pros & Cons

Key Takeaways

• An earnout is a deal structure where part of the purchase price is paid after closing, based on the business hitting specific performance targets.
• Revenue-based and EBITDA-based earnouts are common examples, and EBITDA carries more risk, since a buyer can add costs to the books after closing.
• An earnout can get a deal done when buyer and seller cannot agree on value, and it lets you capture growth a buyer will not pay for upfront.
• Sellers often lose operational control post-sale while still being held accountable for hitting numbers, which is a major tension point in any earnout deal.
• Core Growth Group works with HVAC and plumbing owners well before any earnout terms are negotiated, helping strengthen the numbers and operations that those terms will be based on. 

What Is an Earnout When Selling a Business?

An earnout is a provision in a sale agreement where part of the purchase price depends on the business hitting agreed financial or operational targets after closing. Instead of receiving the full value at closing, you take a payment up front and earn the remainder over a defined period if the business meets those targets.

The metrics used to trigger earnout payments vary widely depending on the deal. Common structures include revenue-based earnouts, where payments are tied to hitting gross revenue targets over a specific period, gross profit earnouts, and EBITDA-based earnouts measured against normalized operating earnings.

The earnout period, the metric definitions, how those metrics get calculated, and what rights you retain after closing are all negotiable and consequential. Vague language in any of them is where deals turn into disputes. Core Growth Group acquires plumbing and HVAC companies in the Texas Triangle, and owners outside our criteria can work with us on preparing for a sale to someone else.

Earnout Examples That Show How They Play Out

Example 1. A Revenue-Based Earnout in a Plumbing Sale

A plumbing company doing $4 million in revenue and $600,000 in adjusted EBITDA sells for $1.8 million, roughly a 3x earnings multiple, with $1.4 million at closing and $200,000 paid at the end of each of the first two years if revenue stays at or above $4 million. The company has cleared that revenue figure three years running, so the target looks reachable. 

After closing, the buyer merges dispatch into another location, raises service call pricing, and moves several commercial accounts to a different branch. Revenue comes in at $3.7 million, and the first payment is not owed.

Was that a performance failure or the result of buyer decisions? That question is what earnout disputes come down to, and the answer depends on what the agreement permits the buyer to change during the earnout period.

Example 2. An EBITDA-Based Earnout in an HVAC Sale

An HVAC company does $5 million in revenue with $1 million in adjusted EBITDA. It sells for $3 million, with $2.4 million at closing and $600,000 tied to holding EBITDA at that level for two years.

After closing, the buyer starts charging the company for services from its head office, including management fees, shared back office support, and insurance bought through the larger group. 

Those charges are new expenses on the company’s books, and they reduce reported EBITDA by $150,000 a year. If operations perform as expected, the target is missed anyway, and the seller receives nothing further.

An earnout measured on profit is only as reliable as the definition of profit in the agreement. If the buyer can add costs to your income statement after closing, the buyer controls the number your payment depends on.

Pros of Earnouts for Buyers & Sellers

1. Sellers Can Capture Full Business Value If Performance Holds

If your business is on an upward trajectory, an earnout lets you monetize future growth that a buyer will not pay for upfront. A seller who has confidence in their own projections has reason to consider the structure. 

When the business hits its targets, the total consideration received can exceed what any buyer would have offered as a clean, all-cash deal at closing.

2. Buyers Reduce Risk by Paying for Proven Results

From the buyer’s side, earnouts are a risk management tool. Instead of paying a full premium based on seller projections that may or may not materialize, the buyer anchors a portion of the price to actual post-closing results. 

This is particularly valuable when acquiring businesses in fast-moving industries, early-stage companies, or any business where a significant portion of value lives in future contracts, pipeline, or relationships.

3. Deals That Would Otherwise Fall Apart Can Still Close

This is the most underappreciated benefit of earnouts. When a valuation gap exists that neither party can negotiate past, an earnout converts an impasse into a workable structure. 

The deal closes, the seller receives meaningful upfront consideration, and both sides retain a stake in the outcome.

4. Sellers Stay Motivated to Drive Post-Sale Performance

An earnout gives a departing owner a financial reason to protect performance during the transition, which matters most in service businesses built on customer relationships. This works when the seller has genuine operational influence over the metrics being measured. 

Negotiate your role, your decision-making authority, and your budget controls before agreeing to stay on in an earnout-dependent capacity.

Cons & Risks of Earnouts

1. Disputes Over Metric Calculations Are Common

Revenue sounds simple until the parties are arguing over deferred revenue, a contract signed in December and invoiced in January, or a customer return that reduces the gross figure. EBITDA is more contentious, since buyers make accounting adjustments, allocate integration costs, and set depreciation policy after closing, all of which move the number the earnout is measured against.

The fix is specificity at the drafting stage. Every metric needs a definition that leaves no room for interpretation. Name who prepares the earnout statement, which adjustments are permitted, and how a disagreement gets resolved. Ambiguity tends to favor the buyer, since the buyer controls the books after closing.

2. Sellers Lose Control But Remain Tied to Outcomes

Operational authority transfers to the buyer at closing. The seller may stay on in a management role, but decisions on pricing, hiring, equipment spending, and service area coverage now require buyer approval or are made without the seller’s input. 

The earnout payment still depends on the outcome of those decisions. That tension is built into the structure, and no amount of careful drafting removes it entirely.

3. Buyers Can Manipulate Financials to Reduce Earnout Payments

Not all of these decisions involve bad faith. A buyer might raise marketing spend, defer revenue recognition, restructure how technicians are compensated, or move customer accounts to an affiliated company, all defensible choices that also make an earnout threshold harder to reach. 

Sellers need covenants requiring the buyer to run the business consistent with past practice and to refrain from actions taken to reduce the earnout.

4. Earnout Periods Create Prolonged Uncertainty for Both Sides

A multi-year earnout means years of reporting, metric tracking, potential disputes, and a financial relationship neither party can fully exit. 

For a seller who wants a clean break, particularly an owner who spent decades building the company, that continued entanglement is wearing. 

For the buyer, a former owner who is motivated but potentially adversarial adds a management burden that never appears in the deal model.

5. Complex Legal Drafting Increases Transaction Costs

Earnout agreements require more legal work than a straight cash-at-closing deal. Every definition, calculation method, reporting obligation, dispute mechanism, and seller protection adds billable hours, and the cost compounds when both sides have experienced counsel negotiating each clause.

Why Plan Your Exit With Core Growth Group?

An earnout moves part of your price into the future and makes it depend on results you no longer fully control. That can work in your favor when the targets are reachable, and it can leave you with nothing when it does not. The terms decide which of those you get, so they deserve attention before anyone drafts them. This is exactly the kind of detail our Exit process is built to get ahead of, before it becomes a point of leverage against you. 

Core Growth Group acquires plumbing and HVAC companies across the Texas Triangle, and we consult with owners who fall outside our criteria on preparing for a sale. Our prep work includes the AI tools we use to clean up reviews, financials, and day-to-day operations, the same details a buyer will scrutinize during earnout negotiations. Either way, you are talking to the buying side of these transactions, which is a different conversation from the one you have with an intermediary. If you want to understand what terms like these would mean for your business, start planning your exit with us. 

Frequently Asked Questions (FAQs)

What percentage of business sales include an earnout?

Earnouts appear in a minority of private business sales, and how often depends heavily on deal size. Businesses with concentrated customer bases, recent growth spurts, or heavy owner involvement attract earnout proposals more often than stable companies with predictable cash flow.

Can an earnout be paid as equity instead of cash?

Yes, though most earnouts are paid in cash. Equity-based earnouts appear mainly when the buyer is a public company or a well-capitalized private one where shares carry a clear value. They also introduce vesting schedules, lock-up periods, and the question of how that equity gets valued when the earnout is met.

What happens if the buyer misses the earnout payment?

Your options depend on what the purchase agreement says. A well-drafted earnout includes remedies for non-payment, such as interest on overdue amounts, the right to pursue arbitration or litigation, and sometimes a personal guarantee or funds held in escrow to secure the obligation. Without those provisions, your only recourse may be a breach of contract claim, which is slow and expensive.

Are earnout payments taxed as capital gains or ordinary income?

Treatment depends on how the transaction is structured and what the payments are considered to represent. Payments treated as additional purchase price generally receive capital gains treatment. Part of each deferred payment is usually recharacterized as interest and taxed at ordinary rates, and payments tied to your continued employment can be treated as compensation. A CPA familiar with M&A transactions should review your specific deal structure, since small changes in how payments are classified can change how they are taxed. 

How do you protect yourself as a seller in an earnout agreement?

Bring in your own transaction attorney and get every metric definition, calculation method, and reporting requirement in writing before signing. Core Growth Group’s high-level strategy consulting helps HVAC and plumbing owners across the Texas Triangle get financials and operations in order well ahead of these conversations. Qualifying businesses can also sell to us directly, with no listing process involved.

 

*Disclaimer: This content is for informational purposes only and should not be considered business, financial, legal, or tax advice. Results vary based on market conditions and individual business circumstances. To learn more about scaling, preparing, or exiting your business, visit Core Growth Group.