What is the ‘earnout’ method to finance acquisitions?

An earnout is called so because the shareholders of the company being acquired ‘earn’ their payments as their company meets certain targets in stipulated time. The entire payment is not made all at one go. Very often the management of the company being acquired may have valued it highly because of the growth potential, but this valuation may look high on present level of profits or cash flows. Earnouts work in this scenario because sellers get paid a certain amount only after the acquired firm reaches a certain revenue level.