Earnout

An earnout is a contingent payment mechanism in M&A where the buyer pays part of the purchase price only after the seller meets predefined performance targets within a set period—typically 1–3 years. Instead of paying the full amount at closing, the buyer holds back 10–40% of equity value, releasing it upon achievement of revenue, EBITDA, user, or customer retention goals.

Earnouts align buyer and seller interests post-acquisition. The seller has skin in the game to ensure smooth transition and operational continuity. For the buyer, it reduces upfront capital risk and ties payment to validated performance rather than projections. Earnout terms are governed by the underlying share purchase agreement (SPA) and defined by specific metrics, calculation methods, and dispute resolution mechanisms.

In India, earnouts have become standard in high-growth SaaS, fintech, and e-commerce M&A. Tax treatment varies: earnout payments are typically deductible for the buyer and taxable as capital gains or business income for the seller, subject to Section 45 (capital gains) or Section 28 (business income) of the Income Tax Act, 1961. The holdback period affects cash flow planning for founders.

Indian startups increasingly encounter earnouts in both domestic and cross-border exits. Major acquisitions like Flipkart's buyout of Jabong (2016) and Swiggy's acquisition of Scootsy (2018) used earnout structures to manage valuation risk and post-acquisition integration. In early-stage deals, earnouts are less common, but serial acquirers like Byju's, Unacademy, and Walmart-backed Flipkart frequently deploy them.

Regulatory considerations: earnout payments don't require separate approval under Companies Act, 2013, but must be disclosed in board minutes and shareholder resolutions if material (typically >10% of deal value). For tax purposes, the earnout liability must be accrued in financial statements under Ind-AS 37 (provisions and contingent liabilities). Founders often face surprises: earnout conditions tied to metrics like 'adjusted EBITDA' can trigger disputes if definition of adjustments isn't crystal-clear in the SPA.

RBI regulations permit cross-border earnout payments under Schedule VII (Liberalized Remittance Scheme) if the underlying acquisition is valid. However, founders should document the commercial substance of earnout targets with their transaction lawyers to avoid Customs and GST complications.