Should a business purchase price include an earnout?

An earnout can be worth considering when buyer and seller want some purchase price to depend on what happens after closing. It works as a decision tool only when both can follow the same calculation, understand who can affect it and see how the buyer would pay.

The American Bar Association's earnout discussion identifies post-closing performance, operating control and access to records as connected concerns. The fictional record below explores those mechanics. It makes no claim about standard terms, enforceability or tax treatment.

Write the price record before testing it

Imagine the acquisition of a small commercial graphics business closing on January 1, 2027. The buyer pays $180,000 at closing, separately funded in full. The seller may also receive one contingent purchase-price payment. There is no seller loan, holdback, interest, seller employment condition or other price adjustment in this example.

Measurement period

January 1 through December 31, 2027.

Eligible receipts

Customer cash collected by December 31 for work completed by this acquired operation during 2027, less refunds paid during that period on those jobs. Sales tax, asset-sale proceeds, intercompany transfers, pre-2027 work and deposits for uncompleted work are excluded. No further refund or adjustment changes the supplied final figures.

Threshold and formula

Twenty-five percent of eligible receipts above $400,000, with a floor of zero and a total cap of $50,000. The percentage applies only to the excess.

Evidence and payment

Monthly job and receipt records are shared with both parties. The final calculation and supporting records arrive by January 31, 2028. Assume no unresolved calculation dispute in the cases below. The resulting amount is due February 28, 2028, with no interim payout.

“Collected” is deliberate. An invoice for finished work that remains unpaid on December 31 does not enter this metric, even if the accounts recognize revenue that year. This measures neither accounting profit nor total bank deposits.

Run two complete payout cases

All figures and terms here are invented. The case totals already apply every inclusion, exclusion and refund rule above. They are not actual company results.

One formula, two possible results

Scroll across to compare payout and payment capacity. Use the arrow keys when the table area is focused.

The deadline cash figures are separate supplied facts about the buyer's unrestricted money after maintaining its operating reserve. There are no other receipts, required payments, available borrowing or funding commitments before that deadline. The 2027 receipts do not remain untouched in the bank; running the business has also consumed cash.

Case A calculates an amount due but does not fund it. The $2,000 gap needs an actual funding change or leaves a payment unmet; it does not disappear because the formula is agreed. Case B can pay the capped amount on the supplied cash facts. Neither case proves what a real buyer would have available.

Follow the decision that changes the metric

Under the fictional arrangement, the buyer controls job acceptance, invoicing and customer payment terms. The seller's operational handover ends March 31. The seller has no continuing right to direct those decisions, but receives the monthly measurement records.

Change one condition within Case A. Suppose the buyer extends terms on $60,000 of work completed in December, moving its collection from December to January 2028. Keep all other eligible receipts unchanged. The 2027 metric falls from $520,000 to $460,000; the earnout becomes $15,000: 25 percent of the $60,000 excess above the threshold.

For this timing branch, assume the buyer can carry the delay, the $60,000 arrives on January 15, 2028, and every other receipt and payment through February 28 stays unchanged. Cash left for the earnout at its deadline is still $28,000; paying $15,000 would leave $13,000.

The completed work has not vanished. The agreed collection cutoff puts its later cash outside the earnout. That result could arise from an ordinary customer accommodation; it does not establish improper intent. It does show why agreeing a percentage is insufficient when one party controls the timing that determines it.

Agree how both parties can check the result

Give both sides a record connecting anonymized job references, completion dates, invoice amounts, receipts, refunds and excluded items. The monthly report should identify changes in payment terms and work moved to another operation. Agree who prepares the calculation, who can ask for supporting evidence and how a disagreement is handled before a payment depends on it.

Then ask whether the proposed division of control is acceptable. More seller approval rights could constrain the buyer's operation; more buyer discretion could make the seller's expected payment harder to influence. The particular agreement needs to address that tradeoff. An ownership percentage alone cannot settle it, as the decision-rights example shows.

Keep the contingent amount separate from closing proceeds; the closing-cash guide follows that distinction. A workable earnout record connects the formula, decision rights, records and payment capacity. If those cannot be made usable for both sides, a simpler price or no agreement remains worth considering.

For a story about the responsibilities that continue around attractive assets, read the opening of Infinite Upside. Its account of ownership changing a founder's relationship with cars is a useful companion to the question of what a deal leaves people doing afterward.