An earnout defers part of the price and pays it only if the business hits agreed targets. It is the standard solution to a buyer and seller disagreeing about the future — and it is the single most common source of post-close disputes in small M&A.
Why they exist
The seller says the business is growing 5% a month and prices accordingly. The buyer thinks that's the last six months, not the next twelve. Neither can prove it. An earnout says: fine, if you're right, you get paid.
Why they go wrong
Because the moment the deal closes, the person controlling the outcome is the buyer, and the person depending on it is the seller. Everything else follows from that asymmetry.
The buyer raises prices, or cuts the ad spend that was driving growth. Revenue dips. Earnout missed.
The buyer changes positioning. Different customers arrive. The target was written for the old ones.
The buyer, quite reasonably, invests in something long-term that suppresses this year's number.
None of these require bad faith. That's the problem: an earnout can fail with everybody behaving honourably.
How to write one that works
Use revenue, not profit. Profit is a hundred discretionary decisions; revenue is close to a fact.
Keep the period short. 6–12 months. Beyond that the business isn't recognisably the one that was sold.
Make it a sliding scale, not a cliff. Hitting 96% of target should pay 96%, not zero. Cliffs create incentives for exactly the behaviour you fear.
Define the measurement source in the document. Which account, which report, which definition of revenue, delivered on which day of the month.
Give the seller visibility. Monthly access to the number they're being paid on. Half of all earnout disputes are really information disputes.
Cap the seller's obligations. If they must stay involved, say precisely how much.
The alternative worth considering first
Often the honest answer is that the earnout is doing work that a lower price and a seller note would do more cleanly. A note pays on a schedule; an earnout pays on a performance the seller can no longer influence. If the disagreement is really about risk rather than about growth, the note is the better instrument.