What Is an Earnout? How Earnouts Work in SaaS Deals

By Phillip Mitchell, Founder & Chief Brokerage Officer, AIExchange.club

Figures are as of October 2026 and tax notes are federal-only. This is general information, not tax or legal advice. Have a CPA and a deal lawyer review any earnout before you sign.

An earnout looks generous on paper. A buyer offers $1M for your SaaS business, $700k at closing and "up to" $300k more if the business hits its targets. The headline says $1M, but the earnout part is a promise, not cash.

Across private deals with an earnout, sellers end up collecting about 21 cents of every earnout dollar, according to SRS Acquiom's 2025 deal terms data. This guide covers what an earnout is, how SaaS earnouts are structured, what one is really worth, how it's taxed, and what to put in the agreement so you land on the right side of that average. If you haven't settled the deal structure yet, read how the deal itself is structured first.

What is an earnout?

An earnout is the part of a business's purchase price that's paid after closing, and only if the business hits agreed targets. In M&A, it's a way to close the gap when the buyer and seller disagree on what the business is worth. The seller believes in the growth plan, the buyer doesn't want to pay for it upfront, so part of the price waits until the growth shows up.

A typical earnout clause says something like: the buyer pays an extra amount if annual recurring revenue reaches a set level by a set date, with a sliding scale between a floor and the target. Miss the floor and that money is never paid.

Why buyers offer earnouts

Buyers use earnouts for three reasons:

• Valuation gaps. If you price your business on next year's growth and the buyer prices it on last year's numbers, an earnout lets both sides sign. The bigger the gap, the more likely an earnout shows up. Our guide to where SaaS multiples sit shows how quickly growth assumptions move the price.
• Risk sharing. If revenue depends on the founder, a few large customers, or one marketing channel, the buyer shifts some of that risk back to the seller.
• Cash. Paying part of the price later, out of the business's own revenue, means the buyer needs less cash or debt at closing.

Earnouts got more common when valuations got harder to agree on. Outside life sciences, the share of private deals with an earnout rose from 15% in 2019 to between 30% and 37% in 2023, then settled at around 22% in 2024, according to SRS Acquiom data cited by the Harvard Law School Forum on Corporate Governance.

On the buyer's books, an earnout is recorded as a liability for contingent consideration at its estimated fair value and revalued each reporting period. That's one reason buyers care how it's written: a loosely drafted earnout is a liability they can't estimate well.

How earnouts are structured

Every earnout answers the same five questions: what's measured, over how long, what triggers a payment, how much, and when it's paid.

Typical earnout terms

Sources: SRS Acquiom 2025 M&A Deal Terms Study and the Harvard Law School Forum summary of SRS Acquiom and ABA deal data.

Earnout payments can be all-or-nothing (a "cliff") or graduated. For a seller, graduated is almost always better. A cliff turns a 2% miss into a 100% loss.

SaaS earnout targets: ARR, MRR, retention and churn

Generic earnout guides talk about EBITDA. In a SaaS deal, the better targets are usually the recurring revenue metrics, because they're what the business is priced on and they're harder for a new owner to move with accounting choices.

The rule of thumb: tie the earnout to the metric you can still influence after handing over the keys, and define it so tightly that two accountants would calculate the same number. If you're unsure whether your business is valued on earnings at all, SDE vs EBITDA covers which figure buyers use.

Earnouts on AI SaaS deals

AI products give buyers extra reasons to ask for an earnout: revenue that's only a few months old, gross margins that swing with model and inference costs, and dependence on a model provider's pricing and terms. If you're selling an AI SaaS business, expect the question and push for a revenue target rather than a margin or profit target. The buyer will control which models the product runs on after closing, and so will control the inference bill.

What an earnout is really worth: a $1M example

Here's a SaaS business doing $330k in ARR. The buyer offers $1M: $700k at closing and up to $300k as an earnout, paid at month 24 based on ARR at that point. The earnout pays nothing below $390k ARR, pays in full at $450k, and scales evenly in between.

Two things stand out. First, the expected value of this offer, using the market average, is about $763k, not $1M. An $850k all-cash offer from another buyer could be the better deal, and it pays you two years sooner. Second, everything above $700k depends on decisions the buyer makes after you've handed over control.

That doesn't mean you should reject every earnout. It means you should compare offers on what you'll actually collect. Start from what the business is worth today in cash, then decide how much of the gap above that you're willing to bet on.

How often earnouts actually pay out

The SRS Acquiom 2025 study found that, outside life sciences:

• Across all deals with an earnout, about 21 cents of every earnout dollar was paid.
• In deals that hit any earnout threshold at all, about half of the maximum earnout was paid.
• In its claims data, about 59% of deals paid some or all of the earnout, which means around 4 in 10 paid nothing.

One caveat: SRS Acquiom's data covers more than 2,200 private acquisitions closed between 2019 and 2024, and most are bigger than a typical SaaS marketplace sale. Treat the numbers as a sign of how often earnouts disappoint, not as a precise forecast for a $1M deal. The pattern, though, is clear: an earnout is worth well below its face value unless the agreement protects you.

How earnouts are taxed

For a US seller, the big question is whether each earnout payment counts as purchase price or as pay for work.

• Purchase price: taxed as a long-term capital gain if you've owned the business over a year. The top federal rate is 20%.
• Pay for work: taxed as ordinary income at up to 37%, plus payroll taxes.

In the $1M example, a fully paid $300k earnout means about $60,000 in federal tax as a capital gain, or as much as $111,000 if it's treated as pay. That's a $51,000 difference before state tax.

Three things push an earnout toward ordinary income, as Frost Brown Todd's tax explainer lays out:

1. The earnout period matches your employment or consulting term.
2. Your post-sale salary is below market, so the earnout looks like the real pay.
3. Payments stop if you leave, rather than continuing regardless.

Two other rules matter. Earnout payments that count as purchase price are usually reported under the installment method, so you pay tax as you're paid rather than all at closing. And because the money arrives late, part of each payment is treated as interest under Section 483 and taxed as ordinary income. Have your CPA model both before you agree to the timing.

What to put in the earnout agreement

Courts mostly read earnout provisions as written. If a protection isn't in the agreement, assume you don't have it. In the ABA's 2023 deal points study, only 25% of earnout deals included a covenant on how the buyer must run the business, such as running it consistent with past practice, so most sellers rely on whatever other language they negotiated. Use this checklist:

1. A precise metric definition. Spell out how ARR or revenue is calculated, which accounting method applies, and how annual plans, refunds, discounts and currency are treated. Attach a sample calculation using your current numbers.
2. A sliding scale, not a cliff. Set a floor, a target and a linear payout in between.
3. Shorter periods and annual tranches. One payment at month 12 and another at month 24 beats a single test at month 24. Add a catch-up so a strong second year can make up for a weak first one.
4. Operating covenants. The buyer agrees to keep the product live and sold under its current brand, keep pricing and marketing spend at agreed levels, and not move customers to another product during the earnout.
5. Information rights. Monthly reports and read-only access to Stripe or the billing system, so you can see the number as it develops.
6. Acceleration. The full earnout is paid immediately if the buyer sells the business, shuts the product down, breaches the covenants or ends your role without cause. In SRS Acquiom's data, almost 25% of deals closed from 2014 to 2023 accelerated the earnout on a change of control.
7. Limits on set-off. Cap the buyer's right to deduct indemnity claims from earnout payments, or require a claim to be resolved before anything is withheld.
8. A dispute process. Name an independent accountant to settle calculation disputes, with fixed deadlines for each step.
9. Security for payment. For a smaller buyer, ask for a guarantee from the parent company or owners, or part of the earnout placed in escrow.

How earnouts go wrong

Most earnout disputes come from the same few moves:

• The buyer merges your product into theirs, so its revenue can no longer be measured on its own.
• Pricing, packaging or the marketing budget changes, and growth stalls.
• Customers are moved to the buyer's other products.
• Costs are reallocated, which is why profit-based earnouts are especially exposed.
• The seller leaves or is pushed out, and nobody is left driving the metric.

Earnout litigation has been rising. The Harvard Law School Forum notes that court filings mentioning earnouts in M&A nearly doubled in the first quarter of 2023 compared with a year earlier. Every item on the checklist above exists to stop one of these moves.

Earnout vs seller note vs holdback

Sellers often mix these up. All three pay part of the price after closing, but only an earnout depends on future performance.

If a buyer can't fund the whole price, a seller note is often a safer ask than an earnout, because the amount is fixed. Our guide to seller notes and acquisition financing covers how they're structured and how lenders treat them.

Should you accept an earnout?

An earnout makes sense when:

• The cash at closing is a price you'd accept on its own.
• The target is a metric you'll still influence after the sale.
• The agreement includes operating covenants and acceleration.
• The buyer has the money to pay it.

It's a warning sign when the closing payment is well below your number and the earnout is supposed to make up the difference, when the target depends on the buyer's decisions, or when the earnout runs longer than two or three years.

Before you negotiate, compare every offer on its expected value, not its headline. Then use the earnout as a trade: give a little on the maximum in exchange for more cash at closing, a shorter period or stronger protections. For the rest of the process, see how to sell a SaaS business.

Earnout FAQs

What is an earnout in M&A?

An earnout is part of the purchase price paid after closing, only if the business hits agreed targets such as revenue or ARR. It's used when buyer and seller disagree on what the business is worth.

How long do earnouts usually last?

The median earnout period is 24 months, outside life sciences. Most run one to three years, and none of the deals closed in 2024 in SRS Acquiom's study ran longer than four years.

What percentage of the purchase price is usually an earnout?

Outside life sciences, the median earnout was 31% of the closing payment in 2024. In the $1M example above, the $300k earnout is about 43% of the $700k closing payment, which is on the high side.

Are earnout payments taxed as capital gains?

They can be, if they're treated as purchase price rather than pay for work. Earnouts tied to your employment, paid alongside a below-market salary, or that stop if you leave are more likely to be taxed as ordinary income. Part of each late payment is also treated as interest.

What happens to an earnout if the buyer sells or shuts down the business?

It depends on the agreement. With an acceleration clause, the full earnout is usually paid immediately. Without one, the earnout may be impossible to earn, so ask for acceleration on a sale, shutdown or breach.

Is an earnout the same as seller financing?

No. Seller financing is a fixed loan the buyer repays with interest, whatever happens to the business. An earnout is only paid if performance targets are met.

Next step: know your number before you negotiate

You can only judge an earnout if you know what the business is worth in cash today. Get a range in a couple of minutes with the estimator below.

For a fuller number, use our free SaaS valuation tool. If you're weighing an offer with an earnout in it, talk it through with us before you sign.