Earn-outs Explained

When a buyer and seller can't agree on what a business is worth, an earn-out can bridge the gap. Rather than settling the entire purchase price on completion, part of the consideration is deferred and made conditional on the target hitting agreed future performance targets. Earn-outs are common in private company M&A, especially where the seller is staying on to run the business, and they bring their own accounting, tax, and negotiation complexity that every finance professional involved in deal work should understand.

What Is an Earn-out?

An earn-out splits the total consideration for an acquisition into two parts: an upfront payment made at completion, and one or more contingent payments made later if the target business meets specific financial or operational milestones. Those milestones are usually revenue, EBITDA, or gross profit targets measured over a defined post-completion period, often one to three years, though non-financial milestones such as retaining key customers or hitting a product-launch date are also used.

Earn-outs are especially common when a buyer and seller have genuinely different views on future performance — for example, a founder convinced their new product line will drive growth, against a buyer who wants to see it proven before paying full price. Rather than one side simply accepting the other's forecast, the earn-out lets both sides be partly right: the seller gets upside if the business performs, and the buyer doesn't overpay if it doesn't.

Why Buyers and Sellers Use Them

For buyers, an earn-out reduces upfront cash outlay and transfers some execution risk back to the seller, who typically has the most influence over near-term performance, especially if they remain as CEO or in another operating role. It can also help close a valuation gap without a protracted negotiation, and it can serve as a retention tool, keeping key founders financially incentivised to stay and deliver results post-acquisition.

For sellers, an earn-out can unlock a higher total price than a buyer would pay for cash upfront, since the buyer isn't being asked to price in all the forecast growth on day one. The trade-off is risk: the seller is exposed to the buyer's management decisions during the earn-out period, and disputes over whether targets were met — or whether the buyer acted in good faith — are one of the most common sources of post-completion M&A litigation.

Structuring the Mechanics

Getting an earn-out right is almost entirely about drafting precision. Key terms that need to be nailed down include the metric used (revenue is harder to manipulate than EBITDA, but EBITDA better reflects profitability), the measurement period and calculation methodology, how the target business will be run during the earn-out (restrictions on the buyer integrating it too aggressively into the wider group, changing accounting policies, or diverting customers elsewhere), and a clear dispute resolution mechanism, typically independent accountant determination, for when the parties disagree on the final numbers.

Caps and floors are also common: a cap limits the maximum additional consideration payable, protecting the buyer from an unexpectedly large payout, while a minimum guaranteed earn-out payment can give the seller some certainty regardless of performance.

Accounting Treatment

Under both IFRS 3 and US GAAP, contingent consideration like an earn-out is recognised at fair value on the acquisition date and included in the total purchase price for goodwill calculation purposes. Changes in the estimated fair value of the earn-out liability after acquisition are generally recognised through profit or loss each reporting period (if classified as a liability) rather than adjusted against goodwill, which means earn-out remeasurement can create real volatility in the acquirer's post-deal income statement. Where earn-out payments are contingent on the seller's continued employment, accounting standards may require treating some or all of the payment as post-combination remuneration expense rather than purchase consideration — a distinction that materially changes how the deal looks in the financial statements.

How Earn-outs Fit Into the Wider Deal

Earn-outs rarely sit in isolation — they interact with how the rest of the purchase price is structured and protected. A seller negotiating an earn-out will often also be negotiating the completion mechanism used to fix the baseline price, and may want warranty and indemnity insurance in place to protect against claims that could otherwise be set off against earn-out payments. Where management is also rolling over equity or taking on debt to fund part of the deal, the earn-out sits alongside structures more typically seen in a leveraged buyout.

FAQ

How long do earn-out periods typically last?
Most run one to three years post-completion, though longer periods are used for sectors like pharmaceuticals or technology where value creation takes longer to materialise.

Can an earn-out payment be zero?
Yes. If the target misses its agreed thresholds, the seller may receive no additional consideration beyond the upfront payment — this is the core risk sellers accept in exchange for a potentially higher total price.

What's the most common source of earn-out disputes?
Disagreements over how the target business was run during the earn-out period, and whether the buyer's decisions unfairly suppressed the metric the earn-out was based on.

Deal structuring, purchase price mechanisms and post-acquisition accounting are core topics across Learnsignal's ACCA and CPD course content for finance professionals working in corporate finance and M&A.

The base purchase price in a deal with an earn-out still needs a completion mechanism of its own — see our comparison of locked box and completion accounts for how the certain portion of consideration is typically priced and adjusted.

Earn-outs also appear in management buyouts, where an exiting owner may want continued upside exposure to a business now being run and owned by its own management team.