Earnouts are one of the most effective tools in mid-market M&A for bridging a valuation gap between buyer and seller. By deferring part of the consideration and tying it to post-close performance, the structure distributes risk across both parties: the buyer pays for results, and the seller earns full value if the business delivers. Structured well, an earnout enables deals that would otherwise stall on price. Structured poorly, it shifts risk almost entirely onto the seller while leaving the buyer in control of the conditions of payment.
This article is written for founders who are starting to think about an exit and how to structure it, as well as for those founders who may already have an LOI on the table with an earnout component. If you need background on how earnouts work in a tech acquisition, start with our full breakdown here. What follows is the negotiation playbook: the decisions that determine whether the earnout you agree to is one you can actually collect.
What is an earnout doing in your deal
An earnout is not a bonus. Or, at least, it shouldn’t be viewed as such.
An earnout is a deferred consideration: a portion of the agreed purchase price that is paid after close, contingent on the business hitting specific performance targets over a defined period. Those targets are typically financial, most commonly a revenue threshold, an ARR number, or a growth figure that the acquired company must reach within 12 to 24 months of closing.
For instance, a buyer agrees to acquire your SaaS business for $30M, structured as $22M at close and $8M in earnout, payable if the company reaches $10M ARR within 18 months. The $8M is not conditional on the buyer's goodwill. It is part of the total consideration both parties agreed to, yet deferred rather than paid upfront.
The buyer believes the business will hit the targets. So do you. The negotiation is about who bears the risk if something unexpected intervenes after the wire clears, and what happens to the earnout if the buyer's own decisions after close make those targets harder to reach.
According to the SRS Acquiom 2025 M&A Deal Terms Study, earnouts appeared in roughly 22% of private M&A deals in 2024, with the median earnout equal to 31% of closing payments. That means, in deals where earnouts are present, nearly a third of what a seller expects to collect may depend entirely on what happens after close. The stakes of the negotiation are proportional to that number.
Furthermore, it is also important to note that earnout use is also likely to increase as AI-native companies become a more significant part of the mid-market M&A pipeline. Many of these businesses are reaching mid-seven-figure revenues faster and more capital-efficiently than prior software generations, but the risk profile buyers assign to them remains high. This is because is limited operating history, short customer cohorts, and uncertainty around retention and sustainable growth make it genuinely difficult for buyers to underwrite future performance at full value on day one. That gap between the seller's view of forward potential and the buyer's willingness to pay for it upfront is precisely the condition earnouts are designed to address.
At L40º, we expect earnout structures to become a standard feature of AI SaaS exits. Not because these businesses lack quality, but because buyers need a mechanism to bridge the gap between strong current revenue and unproven long-term retention. Founders in this segment should plan for it.
How to negotiate earnout metrics
The single most consequential decision in an earnout negotiation is the choice of performance metric (and how to measure it). This is not a technical detail. It can actually become a question of who really controls the outcome after the deal closes.
Revenue is one of the most common metrics given that it can better reflect the effort and work of the seller involved during the transition phase. It is also harder to manipulate because it conveys what customers pay, not what the buyer, for instance, chooses to spend.
In this regard, how your revenue is recognised and reported in your books will also directly affect how earnout calculations are run. Founders who want to understand the implications before entering a process can read our guide to SaaS revenue recognition in M&A.
EBITDA, by contrast, gives the buyer significant influence through expense allocation, headcount decisions, shared service charges, and integration costs. A buyer who decides to increase marketing spend or that absorbs your finance and HR teams into a shared services model can reduce your EBITDA without touching your revenue line. Gross profit sits in the middle, but is still subject to cost-of-goods allocation decisions that the buyer controls.
The market data supports a clear preference on the sell side. In 2024, 62% of earnouts used revenue as the primary metric, while only 22% used EBITDA. If a buyer insists on an EBITDA-based earnout, the negotiation shifts to contractual guardrails: minimum operating budget commitments, restrictions on cost reallocation from the parent entity, and independent accounting review rights. Without those protections, an EBITDA earnout is a promise backed by the buyer’s goodwill rather than enforceable terms.
For most mid-market SaaS deals, ARR retention or total revenue are the cleanest metrics to defend. They align with how buyers already evaluate the business during diligence and are harder to move through accounting decisions made after closing.
Five clauses founders should ask for
Once the metric is set, the next step is to define the how. The clauses that surround an earnout can determine whether you will actually collect that value post-close. These five terms are the ones that matter most.
1. Operating covenants
The buyer must commit, in writing, to maintaining headcount, marketing spend, and product investment at defined levels during the earnout period. Vague language requiring only “commercially reasonable efforts” is not reliably enforceable. Cooley LLP’s analysis of earnout disputes notes that Delaware courts have consistently flagged ambiguous covenants as a primary driver of post-close disputes. Push for percentage-of-revenue floors on marketing spend, headcount bands by function, and explicit restrictions on allocating shared-services costs to the acquired entity.
2. Acceleration clause
If the buyer sells the business during the earnout period, the full remaining earnout must become immediately payable. Without this clause, a buyer can acquire your company, flip it to a third party, and leave you with no recourse against a new owner who has no relationship with you and no obligation under the original agreement. This protection is reasonable to any buyer acting in good faith and should be non-negotiable on the sell side
3. Tiered structure, not binary
All-or-nothing earnouts create unnecessary risk for sellers and unnecessary friction post-close. A tiered earnout pays proportionally for proportional achievement: if the business hits 85% of the revenue target, the seller collects 85% of the earnout. This structure reduces the likelihood of disputes over narrow misses and aligns the buyer’s interest in supporting the business with the seller’s interest in hitting the targets.
Additional bonus point here:If you have high conviction in your company's growth trajectory, it is also worth asking your advisor whether an uncapped earnout structure is realistic in your deal. A standard earnout sets a ceiling: hit the target, collect the defined amount. An uncapped earnout removes that ceiling, allowing the seller to participate in performance above the target threshold, typically through a formula tied to revenue or ARR above an agreed baseline. For a founder who genuinely believes the business will outperform conservative buyer projections, this structure preserves upside.
That said, uncapped earnouts require careful framing in the negotiation. Buyers accept them when they have strong conviction in the business themselves and see the structure as a fair way to share the upside they are already pricing in. They are most applicable in high-growth SaaS deals where the trajectory is demonstrable and the targets are grounded in recent performance, not projections. Asking for an uncapped structure on a deal where the buyer is already uncertain about forward performance is likely to create resistance rather than alignment. The right moment to raise it is when both sides are genuinely optimistic about the outcome and the conversation is about how to share value, not how to manage risk.
4. Information rights
You cannot verify what you cannot see. Negotiate a contractual right to review financial reports, revenue data, and cost allocations on a regular basis as long as it makes sense, throughout the earnout period, not just at the final calculation date. If the buyer controls the reporting, independent access to the underlying data is the only way to validate the numbers you are being measured against… and to keep yourself accountable and on track.
5. Independent dispute resolution
You may want to consider naming a specific accounting firm in the SPA to resolve disagreements over earnout calculations, when applicable. Specify the firm, the timeline, the scope of their authority, and how fees are allocated. It is not unusual for an earnout dispute to be resolved by independent accountants rather than courts, and the resolution mechanism itself becomes a source of conflict if it was not drafted with precision.
How long should the earnout period be?
Standard earnout periods range from 12 to 36 months. For mid-market SaaS transactions, 12 to 24 months is the seller-favorable range. The SRS Acquiom 2025 data shows a clear trend toward shorter periods, with no deals in their 2024 sample extending beyond four years.
The logic is straightforward: the longer the period, the more things can go wrong outside your control. Integration decisions, leadership changes on the buyer side, market shifts, and the accumulation of operational decisions you did not make all compound over time. A 12-month earnout tied to ARR retention is a measurable, manageable commitment. A 36-month earnout tied to EBITDA growth under new ownership is a long-term bet on someone else’s execution.
If a buyer pushes for a longer period, negotiate the structure rather than the duration. Quarterly measurement with partial payouts at each interval is significantly better than a single assessment at month 36. It creates interim checkpoints, reduces end-of-period disputes, and means the seller is collecting incrementally rather than waiting for a single calculation that may be contested.
When to walk away from an earnout entirely
Not every earnout is negotiable into something acceptable. There are structural situations where the right outcome is more cash at close, even at a lower headline, rather than deferred consideration on terms you cannot protect.
The clearest signal is when the buyer refuses to agree to operating covenants. An earnout without enforceable commitments to maintain the business is a promise backed by nothing. If the buyer insists on full operational discretion with no contractual floors on investment or headcount, the earnout is not a bridge to value. It is an option for the buyer to pay less.
Earnout size requires more nuance. A large earnout as a percentage of total consideration is not automatically a problem. If the total consideration is above market and the earnout is the mechanism that gets you to a higher multiple than you would otherwise achieve, the tradeoff can be entirely worthwhile. The relevant question is whether the targets are achievable under the post-close conditions the buyer is offering, with the protections you have negotiated. An above-market headline price with well-structured earnout terms and operating covenants can be a better outcome than a lower all-cash offer.
The scenario where an earnout rarely makes sense is when you are leaving the business entirely at close. Without operational involvement, you cannot influence whether the targets are met. In that case, negotiate for all-cash consideration or a seller note, which carries a repayment obligation regardless of performance.
The role of your M&A advisor in earnout negotiations
An experienced sell-side advisor brings two specific advantages to earnout negotiations:
Firstly, market data: knowing what operating covenant language buyers in your segment have accepted in comparable transactions, what earnout percentages are standard for your deal size, and which buyers are structurally more likely to propose earnouts as a negotiating tactic.
Secondly, precedent: having drafted and negotiated these clauses before, an advisor arrives with language that has been tested rather than constructed for the first time under deal pressure.
Advisors also shape the process in ways that affect whether a large earnout appears at all. A competitive process with multiple interested buyers reduces any single buyer’s leverage to propose a large deferred component. When a seller enters exclusivity with one buyer and no alternatives on the table, the earnout conversation starts from a structurally weaker position. Running a process that preserves competitive tension is often the most effective earnout negotiation strategy available.
At L40°, the overall earnout structure is addressed at the LOI stage, before exclusivity begins. By the time a purchase agreement is being drafted, the framework is largely set. Earlier engagement means more room to shape it.
Work with L40° on your deal structure
Earnout negotiations are most effective when they begin early and are handled by advisors who understand how buyers in your segment think about deal risk. L40° is a boutique sell-side M&A advisory firm specializing in mid-market SaaS and tech founder exits in the $20M to $200M enterprise value range.
If you are evaluating a deal that includes an earnout component, or preparing for a process where one is likely, contact L40º to review potential deal structures. Our team will walk through your specific situation and identify where the negotiation leverage lies.
