Earnouts in Technology Deals

Introduction

Earnouts are a contingent consideration mechanism in which a portion of the acquisition purchase price is paid to the seller only if specified performance targets are achieved after the deal closes. They are one of the most common and most contentious deal structures in technology M&A. One-third of private-target M&A deals in 2024 included an earnout provision (SRS Acquiom 2025 Deal Terms Study), and the technology sector accounts for a disproportionate share of earnout-structured transactions because tech companies often have steep growth trajectories, IP-heavy business models, and uncertain revenue visibility that make it difficult for buyers and sellers to agree on a fixed purchase price. The core purpose of an earnout is to bridge a valuation gap: the seller believes the business is worth more based on projected growth, and the buyer wants to pay for that growth only if it materializes.

How Earnouts Bridge Valuation Gaps

In a typical technology acquisition, the buyer's valuation is based on the target's current financial performance (trailing revenue, ARR, EBITDA), while the seller's expectation reflects projected growth, pipeline value, and strategic optionality. The gap between these two views can be 20-40% of enterprise value for high-growth tech companies. An earnout resolves this disagreement by splitting the total consideration into two components: (1) the upfront payment at close, reflecting the buyer's conservative valuation, and (2) a contingent payment tied to achieving specific milestones over a defined period, reflecting the seller's growth thesis. If the targets are met, the seller receives the full value they sought. If not, the buyer avoids overpaying. The median earnout potential in 2024 rose to 43% of the closing payment (up from 32% in 2023), meaning earnouts now represent a substantial portion of total deal economics when they are used.

Technology companies are especially likely to require earnouts because much of their value is forward-looking: a SaaS company with $30 million ARR growing at 50% is priced on the expectation that growth continues, but the buyer cannot be certain that net revenue retention will hold or that the sales pipeline will convert. Similarly, AI-native companies with pre-revenue or early-revenue models may have promising technology but unproven commercial traction, making fixed-price acquisitions risky for the buyer.

The structure of an earnout defines which metrics trigger payment, over what time period, and under what conditions.

Other common earnout metrics in technology deals include bookings or ARR growth, customer retention rates, product development milestones (shipping a new product version, achieving regulatory approval for a technology platform), and user or subscriber targets for consumer-facing businesses. Approximately 68% of deals with earnouts include multiple metrics, reflecting the complexity of measuring technology business performance through a single indicator.

Delaware courts have seen increasing earnout litigation as measurement periods for deals struck in 2021-2023 have concluded, with disputes centering on whether buyers operated the acquired business in good faith to achieve earnout targets. Common contractual protections include "commercially reasonable efforts" covenants (requiring the buyer to operate the business in a manner consistent with achieving the earnout), anti-sandbagging provisions, standalone operating requirements (keeping the acquired business as a separate unit during the measurement period), and detailed accounting methodology definitions.

For sell-side advisors, the goal is to minimize the earnout component and maximize the upfront payment, negotiate clear and objective milestone definitions, and include covenant protections that prevent the buyer from undermining the earnout through operational decisions. For buy-side advisors, earnouts provide downside protection and align the seller's incentives with post-close performance, but they also create integration constraints (the acquired business may need to operate independently during the measurement period, limiting synergy capture) and potential litigation exposure.