What an earnout is
An earnout is a portion of the purchase price that isn't paid at closing, but later, contingent on the business hitting specific performance milestones (commonly revenue, EBITDA, or in specialized industries like biotech, regulatory or product milestones). It's a way to bridge a gap when the buyer and seller genuinely disagree about what the business is worth.
An earnout doesn't resolve a valuation disagreement. It postpones it, and shifts real risk onto the seller, since payment now depends on the buyer's future execution as much as the business's own performance.
Why buyers and sellers use them
- 01
Bridging a valuation gap
If a seller believes near-term growth justifies a higher price than the buyer is willing to underwrite today, an earnout lets both sides be "right": the seller gets paid more if the growth materializes.
- 02
De-risking the buyer
The buyer doesn't have to pay full price upfront for performance that hasn't happened yet.
- 03
Common in specific industries
Earnouts and their close relative, contingent value rights (CVRs), are especially common in biotech and pharma deals, where a huge share of a target's value depends on future drug approvals.
A real, high-stakes example
In its roughly $20.1 billion acquisition of Genzyme in 2011, Sanofi paid $74 per share in cash plus one Contingent Value Right (CVR) per share, a mechanism functionally identical to an earnout, entitling Genzyme shareholders to further payments if specific milestones for the drug Lemtrada were achieved. View the original deal announcement ↗
The CVR holders later sued, alleging Sanofi failed to use the required "diligent efforts" to actually achieve the milestones, causing them to miss out on hundreds of millions of dollars in potential payments. Sanofi ultimately paid $315 million to settle the dispute. View settlement coverage ↗ This is the core risk of any earnout: the seller's payout depends not just on the business's performance, but on the buyer's good-faith effort after they no longer own it.
What to get right when negotiating one
- →Define milestones as objectively and measurably as possible. Vague standards are exactly where disputes like the one above originate.
- →Negotiate an explicit "efforts" standard (e.g. "commercially reasonable efforts" or "diligent efforts") obligating the buyer to actually try to hit the milestones, not just passively wait and see.
- →Retain some operational input or reporting rights post-close, so you can verify progress toward milestones rather than relying entirely on the buyer's word.
- →Have your advisor and counsel model out realistic scenarios (best case, base case, and the milestone not being hit at all) before agreeing to a structure.