Earnout Negotiation for Founders: Why 79% of Deferred Dollars Never Get Paid
Key Takeaways
The base rate is the headline. Earnouts have historically paid only ~21 cents on the dollar across all deals, with ~28% contested (SRS Acquiom 2025). Negotiate the expected value, not the face value.
Metric choice = control. Rank by who can move the number after close: revenue/ARR (best for sellers, 62% of 2024 earnouts) > gross profit > EBITDA (22%) > net income. For software, defend ARR or total revenue.
Write a blocker for each failure mode: cost dumping → revenue metric/carve-outs; resource starvation → covenant floors; strategic redirection → non-frustration clause; the flip → acceleration on change of control.
Shape over duration. Keep periods to 12–24 months, use quarterly measurement with partial payouts, and structure tiered (proportional) rather than all-or-nothing payouts.
Mind the tax trap. An earnout tied to your continued employment can be taxed as ordinary income, not capital gain. Decouple payment from employment and involve tax counsel early.
Walk away when there are no covenants or no operational role for you to take cash or a seller note instead.
Timing is leverage. Settle the earnout framework at the LOI stage, inside a competitive process, before exclusivity erases your alternatives.
When a buyer slides an earnout across the table, it almost always arrives dressed as good news. "We love the business. We want you to share in the upside." The number looks like part of your price. Mentally, you bank it.
Here is the figure that should change how you read that sentence: across all M&A deals tracked in the SRS Acquiom 2025 Deal Terms Study, earnouts have historically paid out only about 21 cents on every promised dollar. Roughly four out of five deferred dollars never reach the seller. And about 28% of earnouts end up contested, meaning the disagreement you papered over at signing tends to resurface, magnified, while you and the buyer are working under the same roof.
That is not an argument against earnouts. They remain one of the few tools that can rescue a deal stuck on price, and in 2024 they appeared in roughly 22% of private, non-life-sciences transactions. The point is narrower and more useful: the face value of an earnout and its expected value are two very different numbers, and most founders negotiate the first while collecting the second.
This is a playbook for closing that gap. Not the legal boilerplate version the version that treats an earnout as what it actually is: a bet on someone else's behavior after they have your company.
What you're really agreeing to
An earnout is deferred purchase price. A slice of the total, commonly tied to revenue, ARR, or a growth milestone reached within 12 to 24 months, gets paid only if the business performs after close. In 2024, the median earnout outside life sciences ran around 31% of closing payments. So in a deal that uses one, nearly a third of what you expect to walk away with is riding on what happens after you've already handed over the keys.
The mistake is treating that third as money you've earned and merely have to wait for. You haven't earned it. You've earned the right to try to earn it, under operating conditions a new owner now controls. The whole negotiation is about narrowing the distance between "we both believe the targets are reachable" and "the contract makes them collectable even when the buyer's own decisions get in the way."
So before debating dollar amounts, run the earnout through one question.
The only question that matters: who holds the lever?
Every earnout is measured against a metric. The metric's real risk isn't whether it's "fair"; it's who can move it after close. Rank the common choices by how much control sits with the buyer, and the seller's preference order writes itself:
Revenue / ARR moved mostly by customers, not by the buyer's accounting. Hardest to manipulate, which is exactly why sellers want it. In 2024, 62% of earnouts used revenue as the primary metric.
Gross profit sits one layer down, exposed to cost-of-goods allocation decisions the buyer makes.
EBITDA is heavily buyer-controlled. Headcount, marketing spend, shared-service charges, and integration costs all flow through it. A buyer can leave your top line untouched and still shrink the number you're paid on. Only about 22% of 2024 earnouts used it, and there's a reason that figure is low on the sell side.
Net income the most exposed of all. Avoid where you can.
The pattern: the further down the income statement your metric lives, the more of it the buyer controls. For most software exits, ARR retention or total revenue are the cleanest lines to defend, because they map to how the buyer underwrote you in diligence and resist post-close engineering.
If a buyer insists on EBITDA, you haven't lost; you've changed the conversation. Now the deal needs guardrails: a minimum operating-budget commitment, a ban on dumping parent-company costs onto your unit, standalone financials prepared on agreed accounting principles, and the right to inspect them. An EBITDA earnout without those is not a price. It's an option the buyer holds to pay you less.
The four ways a clean-looking earnout quietly fails
Most earnouts don't blow up over fraud. They erode through ordinary post-close decisions that happen to flow against your number. Knowing the four common failure modes lets you write the blocker for each before you sign.
1. Cost dumping. The buyer routes shared services finance, HR, IT, a slice of group marketing into your entity, and your EBITDA quietly deflates. Blocker: a revenue-based metric, or explicit carve-outs and standalone financials that exclude allocated parent costs.
2. Resource starvation. Nobody breaks a promise; they just stop investing. Marketing spend drifts down, two open roles go unfilled, and growth stalls on schedule. Blocker: operating covenants with hard floors marketing as a percentage of revenue, headcount bands by function, not vague "commercially reasonable efforts" language, which Delaware courts have repeatedly singled out as the root of earnout disputes.
3. Strategic redirection. The buyer repositions the product, changes pricing, or reroutes your customers into a different SKU. Revenue moves to a line you're not measured on. Blocker: a non-frustration covenant plus carve-outs that protect the measured metric from buyer-initiated strategy changes.
4. The flip. The buyer sells your unit mid-period, and the new owner has no agreement with you and no reason to honor one. Blocker: an acceleration clause that makes the full remaining earnout payable on any change of control. This one is reasonable for any good-faith buyer and should be close to non-negotiable on your side.
Notice that three of the four are defeated by metric choice and covenants, which is why those two decisions deserve more of your energy than the headline number.
Structure beats duration
Standard earnout periods run 12 to 36 months; for mid-market software, the seller-friendly zone is 12 to 24, and the market has been drifting shorter in 2024; no deals in the SRS Acquiom sample stretched past four years. The logic is simple: time is the buyer's ally, not yours. Every additional quarter adds another integration decision, another leadership change, another market wobble you don't control.
When a buyer pushes for a longer runway, negotiate the shape, not just the length. A single make-or-break measurement at month 36 is the worst possible structure; one bad quarter near the end can erase everything. Quarterly measurement with partial payouts converts that cliff into a staircase: you collect incrementally, disputes get resolved while memories are fresh, and neither side is staring down an all-or-nothing calculation years out.
The same principle applies to the payout curve. An all-or-nothing target is a trap; hit 95%, and you get zero, which is also the structure most likely to end in litigation. A tiered earnout that pays proportionally 85% of target earns 85% of the earnout- removes the incentive to fight over a narrow miss and keeps both parties pointed at the same outcome. And if your growth case is genuinely strong, it's worth asking whether an uncapped structure is realistic, letting you share in performance above the target. That conversation only works when both sides are already optimistic; raise it on a deal where the buyer is nervous, and you'll create friction instead of alignment.
The tax trap most founders never see coming.
Here's a detail that rarely makes it into earnout articles and routinely surprises founders: if your earnout is contingent on you staying employed, you may have just converted capital-gains treatment into ordinary compensation income. Tax authorities have long taken the position that a payment conditioned on continued service looks like wages, not purchase price, and the rate difference can be brutal.
The fix is to decouple the earnout from your employment wherever possible: the payment should follow business performance, not your presence on the payroll. There are also installment-sale interest considerations on larger deferred amounts. None of this is something to improvise in the room loop in deal counsel and a tax advisor early, because the structure is far easier to get right at the term-sheet stage than to unwind later.
When the right answer is "no earnout at all."
Not every earnout can be negotiated into something you'd want. A few signals mean you should push for cash at close even at a lower headline instead:
The buyer won't commit to operating covenants. If they insist on full discretion with no floors on investment or headcount, the earnout isn't a bridge to value. It's the option to underpay you, and you've just described the 79% that goes uncollected.
You're leaving at close. With no operational role, you can't influence the targets. Take cash, or a seller note that carries a repayment obligation regardless of performance.
Size alone, notably, is not a red flag. A large earnout that lifts a deal to an above-market multiple can be a great trade if the targets are reachable under the conditions on offer and the protections you've negotiated. The question is never "how big," it's "how collectable."
The leverage you have before exclusivity and lose after
The single most overlooked move in earnout negotiation is timing. Once an LOI is signed and exclusivity begins, your leverage collapses: you're negotiating against one buyer, on the clock, with no alternative. The metric, the period, the covenants, the dispute mechanism all of it is far easier to shape at the LOI stage, before the buyer knows they're the only one at the table.
This is also where a competitive process earns its keep. When several credible buyers are interested, no single one has the leverage to load the deal with deferred risk. Boutique sell-side advisors like L40° tend to push earnout structure into the LOI conversation for exactly this reason: by the time the purchase agreement is drafted, the framework is mostly set, and the room to improve it has narrowed to drafting nuance. The earnout you can actually collect is usually decided weeks before anyone starts arguing over clause language.
The reframe worth keeping
Stop reading an earnout as the back half of your price. Read it as a probability-weighted bet, and a $10M earnout with a market base rate behind it is worth far less than $10M until your terms move the odds. Everything in this playbook exists to move them: pick a metric the buyer can't quietly move, write covenants that bind, accelerate on a flip, shorten and stagger the clock, decouple from employment, and settle the structure before you give up your alternatives. Do that, and you stop hoping the earnout pays. You make it collectable.
