The Clause That Can Make or Break Your Exit – The Rise of Earnouts in M&A

Its 2025, you have just taken an exit from your startup that you spent the last 6 years to build. You played every card right and grew your company from 0 to $80 million. Now a large private equity firm has decided to acquire it for what it is worth (let’s assume $80 million net of taxes).

This feels like the best day of your life; it marks the end of a long and hard journey, it is the culmination of years of late nights, risk, and relentless persistence. You refresh your bank account, waiting to see the numbers confirm what you’ve dreamed of.

Then — there it is. A $50 million credit hits your account.

But wait — wasn’t the deal for $80 million?

You are shocked to see $30 million disappear. You are left wondering what happened and then you scream fraud but then you read the term sheet carefully, and you realise that the balance 30 million is tied to the performance of your company and in it meeting some targets. Only upon meeting these targets will the remaining 30 million be due and paid in full.

Of course, this is a very extreme example as in the real world, as the founder and seller of the company you are aware of every clause in the contract. I am just trying to make a point, so let’s pretend for the sake of this blog that you were not.

“We were supposed to be celebrating,” the founder said, staring at the term sheet. “But instead, I’m negotiating how I’ll earn the rest of the money I thought I’d already sold my company for.”

That’s the emotional moment many founders face in M&A deals today, when they realize the most important part of their payout isn’t guaranteed upfront. It’s tied to a small but powerful clause called an earnout.

The Hidden Lever in Modern Deals

An earnout is simple in theory: if you sell your company for $20 million, you might only get $10 million today. The rest comes later, if your company hits certain milestones. Usually, these targets are tied to revenue, EBITDA, or user growth under its new owner.

It sounds fair right? Buyers protecting themselves against overpaying and founders keep upside if the business performs and getting a slight increase in valuation if the company hits the target. But in practise, earnouts are often where successful deals end up as nightmares for founders.

Why Everyone’s Using Them Now

The recent surge in earnouts isn’t a random phenomenon, it was born out of a market that’s uncertain, fragmented, and skeptical. In the near zero-interest-rate world of 2021, dealmaking was fuelled by optimism and valuations were through the roof. Buyers were throwing cash at anything with momentum. But post 2022 when interest rates started to rise, liquidity had reduced, and the growth of the economy had slowed. Inflation was high and all of a sudden, the optimism had vanished. No one wanted to pay high prices only for the prospect for growth.

That’s where earnouts stepped in to bridge the valuation gaps.

A similar trend was seen post the Global Financial Crisis. Historically, earnouts are used sparingly, mostly in niche sectors during periods of growth. But their use tends to surge in times of uncertainty when buyers and sellers are unable to agree on the true value of a business. Today they are very common in private equity deals in tech and life sciences where future performance is unpredictable but potentially massive. Instead of arguing whether a startup is worth $50 or $70 million, buyers now say: “Let’s agree on $50M today. If you deliver, you’ll earn the rest”.

The use of earnouts can be broken down into two categories of deals: life science (this includes Biotech and Pharmaceuticals, Medical Devices, Diagnostics and Research Technology) and the non-life science. They are more prevalent in the life science industry, in 1H 2023 91% of all pharmaceutical transactions had provisions for earnouts.

This chart shows the growth trajectory of the use of Earnouts in Europe.

This chart shows the percentage of M&A deals that have earnouts in non-life science sectors and the metrics used by them. There is a clear upward trend and a peak during the time of increased uncertainty (Interest rates started to increase in 2023 due to persistent inflationary pressures in the economy).

The Dark Side of the Deal

Not every earnout story ends well. To understand this better let’s look at what metrics are used in earnouts.

Historically, most earnouts were structured purely on financial metrics such as revenue and EBITDA. Recently they have become more complex and often incorporate several metrics that include both financial and non-financial benchmarks. They can range from factors such as customer retention, Customer Acquisition Cost (CAC) or even tied to the underlying inputs. For instance, in the energy sector, earnouts can be tied to the price of the underlying commodity. In the pharma industry, earnouts tend to be structured around the successful completion of clinical trials or the receipt of regulatory approvals. They can be tied to any specific objective or milestone.

According to a 2024 study by SRS Acquiom, which tracks post-closing M&A data, earnouts achieve about 21 cents on the dollar and are contested at least 28% of the time. Of the 59% of deals that paid anything on the earnout, 17% of them required the earnout to be renegotiated to avoid litigation.

Take the case of a healthtech founder who sold her startup to a large insurer. She stayed on, eager to hit the milestones that would unlock her final $8 million.
Six months post the transaction, the parent holding company changed the budget, cut the marketing spend, and integrated her product into another division. Due to these changes the revenue targets were suddenly unachievable. They were unachievable not because of change in performance but because of control

This is a classic earnout trap: when the founder’s payout depends on decisions they no longer control.

Disputes over earnouts are one of the top causes of post-M&A litigation. The numbers can be ambiguous, accounting standards flexible, and incentives misaligned. What was meant to align interests often ends up doing the opposite.

The Art of a Fair Earnout

A good earnout should not be about clever lawyering or smart accounting but rather about clarity and trust. Deals that work tend to:

• •Define exactly how metrics are calculated (and who controls them)
• •Use measurable outcomes like revenue rather than subjective ones like “synergies”
• •Have transparent reporting and dispute mechanisms
• •Give founders reasonable autonomy to hit their targets

When structured well, earnouts can be powerful motivators that rewards performance while protecting both sides.

More Than a Clause

Earnouts have become a symbol of the new dealmaking era, it represents a cautious, data-driven, and accountability-focused approach. They reflect a shift from “buying promises” to “buying performance.” And for founders, they’re a reminder that the deal doesn’t end when the ink dries, sometimes, it’s just beginning.

In the end, an earnout is more than a clause, it’s a test of alignment, integrity, and execution. It has the ability to turn a sale into a partnership or a celebration into a courtroom battle, just ask HP after its acquisition of Autonomay in 2011.

As more deals rely on them, understanding earnouts might just be the difference between a good exit and a great one.