Earn-out

An earn-out is the part of the purchase price that depends on how the sold business develops after completion. If the company meets agreed targets, usually measured on revenue, EBITDA or the retention of specific customer relationships, the seller receives an additional payment. Earn-out periods of one to three years are common. This lets both sides bridge differing expectations about the future and share the risk.

The choice of metric drives the potential for conflict: revenue targets are easy to measure but vulnerable to margin-eroding growth, while earnings targets sit closer to economic success yet can be affected by group charges, changed transfer pricing or the buyer's integration measures. Well-negotiated clauses therefore contain protections for the seller, such as an obligation to run the business as before, exclusion of specified charges from the calculation, information and inspection rights, and expert determination for disputes. In accounting the same arrangement is called contingent consideration: under IFRS 3 and ASC 805 it is recognised at fair value at the acquisition date. Subsequent measurement depends in particular on whether it is classified as a liability or equity. Deferred consideration is a different matter, being purchase price that is simply payable later without being conditional on any target.

The seller should also clarify the tax treatment, since its timing and amount depend on the specific earn-out terms. It is advisable to set out the calculation basis in the agreement with a worked example, because abstract wording is later understood differently. A calculation run through two or three scenarios prevents a substantial share of the typical disputes. What happens if the business is resold or combined with another during the period also needs settling, since the agreed metric can then no longer be determined unambiguously. Immediate payment or an agreed lump sum are the usual answers.

Note: This explanation is for general information only and does not constitute tax or legal advice. The tax and legal position depends on the individual case and may change with new legislation or case law. For a binding assessment, please consult a qualified tax adviser or lawyer.