{ December 20th, 2006 }
When to Use an Earnout Provision
An earnout is the method of paying the seller of a company based on that company’s future earnings. The earnout will call for additional payments to the seller if the company’s post-sale earnings reach a certain level.
The earnout is useful when buyer and seller do not agree about the company’s future profit stream. A buyer should be willing to pay a higher price for greater future profit, if realized, allowing the seller to get paid the company’s full value as the seller represented at the time of the deal.
About the Author
Ryan Roberts is a startup lawyer and represents technology companies through all phases of the startup process, including incorporation, seed & venture financings, and exit transactions. Click here to learn more about his practice.
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Please consider subscribing to The Startup Lawyer, following @startuplawyer on Twitter, or contact Ryan directly.2 Responses
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Earnouts are used in the acquisition process, not so much the financing process. They may be genuinely interested in your startup, but the numbers are against all startups. Thus, the risk and lower than you believe valuations.
As someone with a start-up in the first phase of financing, I am worried about venture capitalists wanting to much for their money. They are full of rhetoric that seems intended to diminish the value of my business. If they really feel that way, then why are they interested. An earnout seems to be agood way to say,”Okay, if you are right, then you are right, but if I am right, then you will have to pay me.”