What is an earn-out?

Explanation of earn-out

An earn-out is used in transaction structuring to bridge valuation gaps between buyers and sellers, particularly where there is uncertainty around future performance. Instead of agreeing a fixed price upfront, a portion of the consideration is deferred and linked to the achievement of specified financial or operational targets.

These targets are typically based on metrics such as revenue, EBITDA, or profit over a defined period following completion. If the agreed conditions are met, additional payments are made to the seller.

Earn-outs are commonly used in private equity and owner-managed business transactions, especially where growth expectations or forecasts differ between parties. The structure requires clearly defined terms, including performance measures, calculation methods, and governance arrangements, to reduce the potential for disputes.

Key characteristics of earn-outs

Key characteristics of earn-outs include the following:

• They link part of the purchase price to post-completion performance.
• They defer consideration over a defined period following completion.
• They use agreed financial or operational metrics as performance targets.
• They are often used to bridge valuation differences between buyer and seller.
• They require detailed contractual terms to define measurement and outcomes.

How an earn-out works

• An initial purchase price is agreed at completion.
• Additional consideration is linked to future performance targets.
• Performance is measured over an agreed period after completion.
• Payments are made if the specified conditions are achieved.

Example of an earn-out in practice

A UK-based business is sold for an initial £10 million, with a further £5 million payable if EBITDA targets are met over the next two years. If the business achieves the agreed performance levels, the additional consideration is paid to the seller.

Related terms

• Completion accounts
• Locked-box mechanism
• EBITDA
• Purchase price adjustment
• Due diligence
• Mergers and acquisitions
• Deferred consideration

Common misconceptions about earn-outs

An earn-out does not guarantee additional payment, as outcomes depend on post-completion performance.

An earn-out does not eliminate valuation risk, as disputes may arise over performance measurement and interpretation.

Earn-out questions

What is an earn-out in M&A?

An earn-out is a mechanism where part of the sale price is contingent on the future performance of the business after completion.

Why are earn-outs used?

Earn-outs are used to bridge differences in valuation expectations and to align consideration with future performance.

How is an earn-out calculated?

An earn-out is calculated based on agreed performance metrics, such as revenue or EBITDA, measured over a defined post-completion period.

What are the risks of an earn-out?

Risks include disagreements over performance measurement, changes in business operations after completion, and uncertainty over whether targets will be achieved.

How long does an earn-out last?

Earn-out periods typically range from one to three years, depending on the transaction and agreed terms.