What is an earnout actually worth at signing?
A milestone-based earnout looks like a real number. The probability-weighted present value tells a different story.
A buyer offering 100 million dollars cash plus a 50 million dollar earnout over three years is not offering 150 million dollars. The earnout is conditioned on hitting metrics that may or may not be hit, payable in years that introduce time value, with dispute mechanics that may or may not be friendly to the seller.
The earnout PV calculator applies the basic math. For each milestone, multiply the payment by the probability of hitting it, divide by (1 + discount rate)^years, sum across milestones. Use a discount rate that reflects the actual risk of waiting (12 to 18 percent is typical for the operator side).
What the math reveals
A 50 million dollar earnout structured as 20 million in year one (70% likely), 15 million in year two (50% likely), and 15 million in year three (40% likely), discounted at 14%, has a present value of about 18 million dollars. That is not nothing. It is also not 50 million.
When a seller is evaluating a structured offer, the comparison should be 100 million cash plus PV of earnout vs whatever alternative is on the table. Often the answer is that the cash-up-front bid at a lower headline number is better than the bigger nominal bid that includes an earnout.
Where the model breaks
Real earnouts have dependency structures (hitting year one matters for year two probability), accelerator clauses (sale of the target triggers full payment), clawbacks (year three payment is reduced if year two missed), and operational covenants (buyer cannot impose costs that depress the metric). None of those show up in this simple PV. The tool is a first-pass sanity check. The actual valuation work for a real deal requires modeling the dependencies and the buyer’s likely behavior.
Walter Allison is a corporate attorney in Denver. He writes here about M&A, private equity, and venture capital structure.
Follow on LinkedIn ·
Firm bio ·
More posts