What is an earnout and when is it used?

An earnout is part of the price paid later, and only if the business hits agreed targets such as revenue or EBITDA in a future year. It bridges a valuation gap: the seller believes the forecast, the buyer does not, so the buyer pays the certain part at closing and the rest only if the forecast comes true. Earnouts are common in private deals and often end in disputes over how the target was measured.

What is the difference between a breakup fee and a reverse termination fee?

A breakup fee is paid by the target to the buyer if the target walks away, usually to take a better offer. It compensates the buyer for the time and cost of a deal that did not happen. A reverse termination fee runs the other way: the buyer pays the target if the buyer cannot close, typically because its financing failed or regulators blocked the deal.

Who bears the risk in a fixed exchange ratio deal?

The target's shareholders. With a fixed ratio they receive a set number of buyer shares per target share, so if the buyer's stock falls before closing, the dollar value they receive falls with it. In a floating ratio deal the dollar value is fixed and the number of shares adjusts, so the buyer bears the risk through extra dilution.

Why does a board get a fairness opinion?

Because directors owe shareholders a duty to make an informed decision when they sell the company. A fairness opinion is a bank's letter saying the price is fair to shareholders from a financial point of view, backed by a full valuation. It is evidence that the board did its homework. It is not a promise that the price was the highest possible.

M&A

Deal terms and protections: what moves value besides price

By SuperdayReps · Michigan Ross Undergrad | Wharton MBA · ex-Citi | ex-Greenhill · Former Head Mentor at a Leading IB Prep Service

13 min read · updated October 14, 2026

Two offers arrive for the same company. One says $500 million. The other says $460 million. Most people stop reading there and pick the first. A banker keeps reading, because the $500 million offer pays $400 million at closing and the other $100 million only if the business doubles its profit in two years, while the $460 million is all cash on the day the deal closes.

The headline price is what gets reported. The terms are what the seller actually receives. This lesson covers the terms that move value between the two sides, the protections that hold a deal together between signing and closing, and the stock deal mechanics that decide who wears a falling share price. If you have not read what a sell-side M&A process looks like, start there; this picks up at the point where bids are being compared.

Terms that move value

Every term below answers the same underlying question: who carries a risk that neither side can fully see today?

Earnouts

An earnout is part of the price paid later, and only if the business hits a target. It exists to bridge a valuation gap. The seller says next year's EBITDA will be $60 million and the business is worth $500 million. The buyer believes $45 million and $400 million. Neither can prove it. So they agree on $400 million at closing plus up to $100 million more if EBITDA actually reaches $60 million.

The seller gets paid for the forecast it believes in. The buyer only pays for the forecast if it comes true. That is the theory. In practice, earnouts are a common source of lawsuits, because once the buyer owns the business it controls the things that decide whether the target is hit: pricing, hiring, cost allocation, even which accounting choices are made. A seller negotiating an earnout spends as much time on how the target is measured as on the number itself.

Escrows and holdbacks

The seller makes promises in the definitive agreement (called representations and warranties): the financials are accurate, there are no undisclosed lawsuits, the taxes are paid. If one of those turns out to be false after closing, the buyer wants a way to get money back. Chasing a seller who has already spent the proceeds is hard.

So a slice of the price, often around 10%, is parked with a neutral third party in an escrow for 12 to 18 months. Valid claims are paid from it, and whatever is left goes to the seller at the end. A holdback does the same job, except the buyer simply keeps the money itself instead of using a third party. Same economics, more trust required from the seller. In many private deals today, representations and warranties insurance replaces most of the escrow: the buyer claims against an insurer, and the seller walks away with more cash at closing.

Seller notes

Sometimes the buyer cannot or will not fund the whole price at closing. A seller note lets the seller take part of the price as an IOU from the buyer, paid with interest over several years. The seller has become a lender to the business it just sold, usually ranking behind the bank debt. It helps a buyer that is short of financing, and it signals the seller believes the business can carry the payments. The cost to the seller is risk: if the business struggles, the note is the first thing that does not get paid.

Working capital adjustments

This is the term students forget, and it is the one that comes up on almost every private deal. A buyer pricing a business assumes it comes with a normal amount of working capital: enough receivables and inventory, net of payables, to run the business on day one. Without a mechanism, the seller could collect every receivable early, stretch every payable, run inventory down, keep the extra cash, and hand over a business that needs an immediate cash injection.

The fix is a peg: an agreed normal level of net working capital, usually based on a trailing average. At closing, actual working capital is measured against it, and the price moves dollar for dollar.

	Amount
Agreed price	$400m
Working capital peg	$50m
Actual working capital at closing	$42m
Shortfall	$8m
Adjusted price	$392m

Deliver more than the peg and the seller is paid more. Deliver less and the price falls. The negotiation is over where the peg sits, and in a seasonal business that fight can be worth millions.

Rollover

In a private equity deal, the sponsor often asks the founder or management to roll over part of their proceeds: instead of taking 100% in cash, they reinvest, say, 20% into the new company alongside the sponsor. The seller takes less cash today and keeps a stake in the upside. The sponsor gets two things it values: less equity to write, and a management team whose incentives point the same way as its own. A seller who refuses to roll anything is sending a signal about how much they believe in the plan they just sold.

Key insight

Price is a number. Value is a number multiplied by the probability you actually receive it. A dollar of earnout is worth less than a dollar of cash at closing, a dollar of seller note is worth less than either, and a dollar in escrow is a dollar you may never see. When a banker compares bids, the first job is converting every offer into what it is really worth to the seller.

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Frequently asked

What is an earnout and when is it used?: An earnout is part of the price paid later, and only if the business hits agreed targets such as revenue or EBITDA in a future year. It bridges a valuation gap: the seller believes the forecast, the buyer does not, so the buyer pays the certain part at closing and the rest only if the forecast comes true. Earnouts are common in private deals and often end in disputes over how the target was measured.
What is the difference between a breakup fee and a reverse termination fee?: A breakup fee is paid by the target to the buyer if the target walks away, usually to take a better offer. It compensates the buyer for the time and cost of a deal that did not happen. A reverse termination fee runs the other way: the buyer pays the target if the buyer cannot close, typically because its financing failed or regulators blocked the deal.
Who bears the risk in a fixed exchange ratio deal?: The target's shareholders. With a fixed ratio they receive a set number of buyer shares per target share, so if the buyer's stock falls before closing, the dollar value they receive falls with it. In a floating ratio deal the dollar value is fixed and the number of shares adjusts, so the buyer bears the risk through extra dilution.
Why does a board get a fairness opinion?: Because directors owe shareholders a duty to make an informed decision when they sell the company. A fairness opinion is a bank's letter saying the price is fair to shareholders from a financial point of view, backed by a full valuation. It is evidence that the board did its homework. It is not a promise that the price was the highest possible.