[gnicholas]

I used to be a lawyer in SV, and whenever my lawyer friends talk about earnouts, it's always in the context of what a bad deal they are for founders.

Basically, they take a lot of lawyer time to negotiate, in order to make them as close to airtight as possible. And if anything goes wrong, it takes a lot of lawyer time to resolve them. And lawyer time equals money (as much as $2k/hr, billed in 6 minute-increments). So you could pay six figures negotiating an earnout, and another six figures when things don't go as planned. That doesn't mean they're always a bad idea — just the vast majority of the time.

A candid lawyer will counsel you away from an earnout, and if a lawyer doesn't mention the potential downsides of earnouts, I'd consider that a big red flag.

[gamblor956]

I work for a company that does a lot of acquisitions. Basically all of our acquisitions involve earnouts, and they're never a bad deal for the sellers. In many cases, without the earnout the deal doesn't happen because the price the seller wants is higher than we'd be willing to pay unless the continued performance of the business post-acquisition justified the higher price tag.

But whether earnouts are good or bad for sellers is industry specific. I don't work for a tech company, and we don't deal with VC or PE firms at all. Our acquisitions are all companies with real revenue streams, established histories of revenue, and non-tech business models that don't require exponential growth or "scale", so earnouts are extremely straightforward.

[pottertheotter]

All of the horror stories I've heard from others about earnouts involved "companies with real revenue streams, established histories of revenue, and non-tech business models that don't require exponential growth or 'scale'". There's so many ways that even the most "straightforward" of earnout terms becomes non-straightforward.

[gnicholas]

Yes, earnouts can help bridge a valuation gap — and if the buyer is reasonable/kind, then they can create a win-win scenario. The question is whether a seller can accurately identify whether their counterparty is reasonable/kind. This is the sort of thing that lawyers should be able to help with, since they're involved in many deals. But as mentioned above, they may have misaligned interests that cloud their judgment.

[tptacek]

Earnouts worked great for us, but services businesses aren't product businesses; I wouldn't be surprised to learn that effectively every services acquisition is back-loaded with earnouts.