Earnouts bridge valuation gaps when buyer and seller disagree on what the route is worth. They're a powerful tool, and frequently misused.
When earnouts make sense. The seller is asking $X for the route, but $Y is justified by trailing financials. The gap is the seller's belief about (a) recently added accounts that haven't seasoned yet, (b) a price increase that hasn't fully landed, (c) a pending contract with an HOA. Earnout: "We'll pay the gap if those accounts are still here in 12 months."
Common structures.
- Retention-based: % of purchase price held back; released at 6 and 12 months based on % of customers retained. Example: 15% held back, full release at 90% retention, sliding scale below.
- Revenue-based: seller earns additional payments if trailing-12-month revenue grows above a threshold over 12–24 months.
- Account-specific: for one or two big accounts whose retention is uncertain (HOAs, commercial), tie additional payments to those specific accounts being on the books at month X.
Seller perspective. Earnouts share risk you'd otherwise be paid to take. A 15% holdback at full release is the same money, you just wait. Push for clear, objective metrics; vague earnouts ("growth at the buyer's discretion") are worth zero.
Buyer perspective. Earnouts protect you, but they create accounting and operational complexity. You owe the seller money for performance you partly control, which can sour the relationship and the transition. Use them when the gap is large (>15% of value) and the risk is real (>30% chance of underperformance), not as a default.
Tax note. Earnouts can be treated as additional purchase price (capital gains for seller) or as compensation (ordinary income). Structure intentionally, and have your CPA involved before signing.