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when you hear about mergers and acquisitions in the news you typically hear something like company a is acquiring Company B for ten million dollars and that makes it seem like this ten million dollars is a fixed price sometimes it is but sometimes it's not you could have a contingent payout that's part of the deal and that is what in earn-out is and are not satai p-- of contingent payout specifically it's an agreement that's gonna allow the seller okay so the shareholders who own stock and Company B let's say Company B is the target here they're gonna be entitled to receive additional money if the target company were to hit certain financial goals in the next few years so for example if you are acquiring company B's so you know what I'll pay 10 million dollars upfront but if in the next year your company's a company B's net income is at least two million dollars then I'll kick in an additional five hundred thousand so then you'd be paying 10 million plus potentially an additional five hundred thousand to the shareholders of Company B but if Company B did not hit that earnings target then it would just be well it's just a 10 million they didn't achieve the earn out so again it's just a contingent payout and it's based on financial target the target don't have to be earnings it could be sales you say okay if sales increased by ten percent over the next year then there's gonna be this additional payout to the shareholders of the target company so why would an iron out be used well typically you see some kind of disagreement about what the purchase price should be so you say okay well let's say we've got Amazon they want to acquire some other company let's say the company cat diapers so Amazon says well we really want to be in the business of cat diapers we want to acquire cat diapers we think cat diapers is worth fifty million dollars but cat diapers says hey wait a minute we've got a really valuable company here we think we're worth 75 million and we're not gonna take a penny less and so okay what's gonna happen here the selling shareholders right the potential selling shareholders the cat diapers they don't want to sell for fifteen million dollars but that's why Amazon wants to pay so we've got a valuation gap here in the ER now can bridge this gap Amazigh could say look we will give you 50 million plus we will give you an additional 25 million but will give so then you're getting the full 75 that you think cat typers is worth but we're only gonna give you this additional 25 million if cat diapers does 10 million dollars in profit for each of the next three years so then if cat diapers does not do that if they don't reach that earnings goal then Amazon is like well hey look we gave you your shot and so we're only paying the fifty million right we're not gonna give you the extra 25 million because you didn't hit the goal so if there's a discrepancy over what the value of the firm is then the earn out could be like okay look we'll meet you in the middle yeah if the company does as well as you say it's gonna do we'll give you the extra twenty five million dollars also it gives this seller an incentive to really stay basically on board and kind of help the buyer transition into owning this new business and I've seen this particularly with small businesses sometimes the small business they sell and then the new owner comes in and the new owner needs a little bit of help with figuring out the accounting different things and so forth and sometimes when you say the seller if there's no earn out or anything or no incentive for the seller to help the buyer then the seller could just say look these are your problems I sold you to business and they just kind of walk away don't reply to email and so forth and the buyer can be frustrated but when you have the earn out now the seller has an incentive to make sure that okay well things are gonna go well because if things do go well and the company hits some financial targets I'm going to get more compensation so an example of an actual earn out the company Disney they used an earn out when they acquire the company clubpenguin in 2007 okay so basically what happened was Disney said look we'll pay 350 million we're gonna pay 350 million for Club Penguin and that was upfront cash okay so they're paying 350 million but but they said look we'll give you an extra 350 million if you hit profit goals right so we've got these earnings targets they didn't specify what they were but they said in 2008-2009 the next couple years for the deal was in 2007 and they say okay the next couple of years if you hit these earnings targets we'll give you an extra 350 million so then the deal would be for 700 million so basically Club Penguin had a chance the shareholders of Club Penguin had a chance to get 700 million dollars in total if Club Penguin was profitable right if they if they hit the targets that Disney had set for them but unfortunately spoiler alert that didn't happen okay so the art of 350 million did not come through the shareholders a club penguin they only got 350 million because they didn't did they earn out didn't didn't get realized they did they didn't hit the earnings target I'll put a link to Disney's 10k with this disclosure in it in the description section of the video if you're curious to learn more