Definition of Earnout
What is an "earnout"? What is the definition of the term "earnout"?
An "earnout" is something that is included in a contract that allows the seller of a business to earn additional compensation after the sale has been completed.
For instance - you run an online coupon site and a major Internet firm wants to purchase it from you. After some back and forth, you agree on a sale price - $4 million cash, plus an "earnout" that will pay you 2% of revenues over the next three years.
If the site brings in $10 million in revenues in the three years following the acquisition, you would be entitled to an additional $200,000 ($10 million * 2%) per the terms of your contract.
This is an "earnout". "Earnouts" are usually based on some percentage of sales or profits.
Many transactions will involve keeping the founders of a business onboard for a certain period of time (usually 1-3 years). An "earnout" clause in the purchase contract can help to keep the founders motivated. In addition, an "earnout" clause will usually help seal the deal if the purchaser is unsure about the transaction, as it means that they will be required to put up less money initially.
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