Does the earnout reward the behavior the buyer wants?
A poorly selected metric can put buyer and seller incentives in conflict.
An earnout is intended to align buyer and seller around future performance. The wrong metric can do the opposite.
Consider a revenue-based earnout. The seller may favor aggressive discounts, extended payment terms, or low-margin projects because revenue increases the payout. The buyer, now responsible for the long-term economics, may prefer profitable growth and disciplined working capital.
An earnings before interest, taxes, depreciation, and amortization (EBITDA) earnout creates different tensions. The buyer may want to invest in salespeople, systems, product development, or integration, while the seller may resist costs that reduce near-term EBITDA. Conversely, the buyer may allocate corporate expenses to the acquired business or delay revenue-generating investment, lowering the earnout even if the business remains sound.
The answer is not always a more complicated formula. Complexity can create more interpretation risk. A good metric should be closely connected to the value being tested, measurable from reliable records, and influenced by the people whose behavior it is meant to motivate.
The parties should test the formula against realistic decisions before signing. What happens if pricing changes, a large customer is transferred, shared services are introduced, or the buyer approves an acquisition? If reasonable business decisions create irrational earnout outcomes, the metric needs revision or protective adjustments.
Earnouts work best when the buyer can operate sensibly and the seller can see a fair path to payment.