Your Earn-Out Is Worth Less Than You Think

That $30M earn-out looks great on the LOI. But the milestones are controlled by the acquirer, the measurement period is vague, and the tax treatment is ordinary income.

Every founder I've worked with remembers the moment their banker presented the "total consideration" number. It's always bigger than the cash at close. That's by design. The gap is filled with earn-outs, escrow holdbacks, and equity rollovers — components that look like money on a term sheet but behave very differently in practice.

Earn-outs are the most misunderstood. A $30M earn-out tied to revenue milestones sounds straightforward. But who controls the revenue? After the acquisition, the acquirer does. They decide the sales strategy, the pricing, the resource allocation. If they pivot the product or merge your team into a different division, those milestones become unreachable — and there's usually no recourse.

Then there's the tax treatment. Cash at close is typically taxed as capital gains. Earn-out payments are often classified as ordinary income — which means a 37% federal rate instead of 20%. On a $30M earn-out, that's a $5M difference in taxes alone. And if the earn-out is structured as compensation (which acquirers prefer because it's deductible for them), you're also paying payroll taxes.

The escrow holdback is another trap. A 15% holdback for 18 months with broad indemnification triggers means the acquirer can claw back millions for representations and warranties claims — some of which are subjective. We've seen founders lose 40-60% of their escrow to claims that were negotiable at signing but weren't negotiated hard enough.

Equity rollovers into the acquiring entity are the subtlest risk. You're trading liquid stock for illiquid equity in a company you don't control. Liquidation preferences often sit above your position. And the timeline to liquidity is uncertain — it could be 3 years or 10.

The point isn't that these components are bad. It's that they need to be valued properly. A $30M earn-out with acquirer-controlled milestones and ordinary income treatment is worth maybe $12-15M on a risk-adjusted, after-tax basis. Your banker won't tell you that because their fee is based on the headline number.

We sit next to your M&A counsel and translate every component into what you actually keep.