Earnout: What is an Earnout?

What is an Earnout?

An earnout is a contractual clause used in mergers and acquisitions (M&A) that provides for additional payment to the seller, contingent upon achieving predefined performance targets. In practice, part of the purchase price is not paid immediately at transaction closing but deferred over a future period (typically 1 to 3 years), and its payment depends on achieving certain objectives — revenue, EBITDA, customer count, key team retention or other KPIs agreed between the parties.

This mechanism is particularly common in startup and technology company acquisitions, where accurately valuing the company is often complex. The earnout bridges the gap between the seller's asking price (who believes in the company's future potential) and what the buyer is willing to pay (wanting to limit risk). In Belgium, earnouts are common in tech sector transactions and typically represent 20 to 40% of the total acquisition price.

The earnout operates within a precise legal framework, usually defined in the Share Purchase Agreement (SPA). Calculation conditions, measurement periods, verification mechanisms and payment terms are negotiated in detail to prevent subsequent disputes.

Why Earnouts Matter

The earnout is a powerful negotiation tool that unlocks transactions that would not otherwise close. Its importance manifests in several contexts:

• Bridging the valuation gap: when seller and buyer disagree on the company's value, the earnout provides common ground by linking part of the price to actual future performance.
• Reducing buyer risk: the buyer only pays the full price if the acquired company achieves the promised targets, protecting their investment against post-acquisition disappointment.
• Maximising seller price: if the company performs according to projections, the seller obtains a total price higher than what they would have received with a single payment without earnout.
• Aligning post-acquisition interests: when founders remain in the company after the sale (common in tech), the earnout incentivises continued performance and facilitates the transition.
• Facilitating startup acquisitions: for young companies whose value largely rests on future projections, the earnout enables structuring a credible transaction.

How It Works

An earnout is structured around several fundamental elements. The first is defining targets (earnout targets): performance metrics the acquired company must achieve to trigger payment. The most common targets are financial — revenue, EBITDA, gross margin, ARR — but may also include operational criteria such as customer count, retention rate or new product launch.

The measurement period (earnout period) defines how long targets are evaluated. It typically spans 1 to 3 years after transaction closing, with annual or semi-annual milestones. The earnout amount can be binary (all or nothing) or progressive (proportional to the degree of target achievement).

The calculation mechanism must be defined with extreme precision to avoid disputes. Who prepares the reference accounts? Which accounting standards apply? How are extraordinary items treated? What is the independent auditor's role? All these questions must find clear answers in the contract.

Finally, seller protection clauses are generally negotiated: the buyer commits to managing the acquired company in good faith, not taking decisions that would artificially sabotage earnout targets and maintaining sufficient investment and resources to enable target achievement.

Concrete Example

Imagine a Belgian startup specialising in logistics automation that developed its platform with Kern-IT and reached 2 million euros in ARR. A French industrial group wishes to acquire it to complement its digital offering. The seller values the company at 15 million euros (7.5x ARR) based on growth prospects. The buyer is willing to pay 10 million euros upfront, considering execution risk justifies a discount.

The solution: a fixed price of 10 million euros at closing, plus a 5 million euro earnout conditional on achieving targets over two years. If the startup reaches 3.5 million ARR in year one, 2.5 million in earnout is released. If it reaches 5 million ARR in year two, the remaining 2.5 million is paid. Both founders remain in their roles during the earnout period to ensure transition and growth.

This structure satisfies both parties: the buyer limits initial risk and only pays the full price if growth materialises. The founders, confident in their product and market, accept the structure as they are convinced they will meet the targets. The result: the startup reaches 4 million ARR in year one (target exceeded) and 5.5 million in year two, triggering full earnout payment.

Implementation

1. Define clear, measurable targets: favour objective financial metrics (ARR, EBITDA) over subjective indicators. The more precise the targets, the less room for disputes.
2. Negotiate the calculation method: specify applicable accounting standards, treatment of exceptional items, the independent auditor's role and the disagreement resolution process.
3. Protect the seller: include clauses preventing the buyer from sabotaging earnout targets — maintaining investment levels, prohibiting customer transfers, requiring good faith management.
4. Limit duration: favour short earnout periods (12 to 24 months) to limit uncertainty and complexity. Earnouts exceeding 3 years are generally inadvisable.
5. Plan resolution mechanisms: define a clear process for disagreements on earnout calculation: mediation, arbitration or independent expert assessment.
6. Anticipate tax implications: consult a tax advisor to optimise the earnout's tax treatment, which varies depending on legal qualification (purchase price supplement vs compensation) and applicable Belgian law.

Associated Technologies and Tools

• Financial reporting tools: Xero, Pennylane or Exact Online to generate the transparent financial reports needed for earnout target monitoring.
• Data room platforms: Datasite, Intralinks or DealRoom to manage transaction documents and post-acquisition tracking securely.
• Business intelligence: Metabase, Looker or Power BI to build real-time earnout KPI tracking dashboards shared between seller and buyer.
• Legal tools: Ironclad or Juro for managing and tracking complex earnout-related contractual clauses.
• Financial modelling: Causal or structured Google Sheets to simulate different earnout scenarios and evaluate the expected transaction value.

Conclusion

The earnout is an elegant mechanism that unlocks M&A transactions by reconciling the divergent interests of seller and buyer. For tech startup founders in Belgium, understanding the earnout is essential as it features in the majority of exit transactions. The key to success lies in contractual drafting precision and defining truly measurable, indisputable objectives. At Kern-IT, we work with companies building platforms designed to grow and potentially be acquired. The product's technical quality plays a direct role in acquisition valuation and in the ability to achieve post-transaction earnout targets.