An earn-out structure helps bridge this valuation gap. It ties part of the purchase price to how the business actually performs later, rather than paying everything upfront.
This method shows up in a lot of merger and acquisition transactions, especially when parties are struggling to agree on price or when future growth is what’s really driving the deal’s logic.
Earn-out payments let buyers limit their risk by holding back part of the purchase price until the business hits agreed targets. These targets usually include specific financial measures like revenue levels, profit margins, or customer retention rates.
For sellers, an earn-out can mean extra payment beyond the initial amount if those expectations are met, turning projected growth into real financial benefit.
What is an Earn-Out and When Should You Use One?
An earn-out is a contractual provision that makes part of the purchase price contingent on the future performance of the business after acquisition. This structure’s become pretty common in M&A transactions.
About 22 percent of deals in 2024 included some form of earn-out component, up from 20 percent in 2018 and 2019.
Earn-outs typically make up 10 to 25 percent of the purchase price. Most middle market transactions consist of cash representing 70 to 80 percent of the value, while earn-outs and escrows account for the remaining 20 to 30 percent.
The typical earn-out period ranges from one to three years, though you’ll see longer periods in certain sectors.
Having a clear duration and defined earn-out percentage lets both parties tailor payouts to the company’s risk profile and performance expectations. Setting targets for a one to three-year period helps parties avoid the common mistakes you see in longer agreements.
How Earn-Outs Function in Acquisitions
Earn-outs tie a segment of the total consideration to specific post-completion results. The buyer commits to additional payments if the acquired company meets clear performance benchmarks. These might include revenue targets, profit levels, or key customer wins.
This works well for deals where expectations about future growth differ. When payment is linked to outcomes, buyer and seller share the risk and reward. Your documentation should spell out each performance test, the calculation method, and the timing of any payout.
Earn-outs suit several business scenarios, most commonly when buyer and seller just can’t bridge the valuation gap through fixed pricing alone. They show up frequently in industries where future profitability depends on completing projects, launching products, or capturing new customers.
The use of earn-outs among technology and startup deals reflects sector realities. For example, a growing share of tech transactions tie earn-out payments to product launches and user acquisition targets.
Advantages of Earn-Outs for Buyers and Sellers
Buyers limit their exposure by retaining part of the payment until the business delivers agreed results. Earn-outs also encourage sellers to support a smooth transition, since their financial upside depends on the ongoing success of the business.
For sellers, there’s an opportunity to receive extra benefit if ambitious projections are achieved over the agreed period. When structured with detailed metrics, clear timelines, and reliable protections, earn-outs offer a practical tool for balancing risk in M&A deals.
Key Earn-Out Structures and Metrics
Revenue-based earn-outs link additional payments to hitting specific revenue targets within the agreed period. Because revenue numbers are easy to verify from your accounts, both sides can track progress without much debate.
Sellers generally prefer revenue-based targets as they’re less vulnerable to manipulation. For instance, a software company might set an earn-out based on reaching £5 million in annual recurring revenue within 18 months of closing.
EBITDA (earnings before interest, tax, depreciation, and amortisation) and profit-based structures come into play when you need a clearer picture of what the business actually earns. These earn-out arrangements focus on factors such as operating profit or EBITDA.
The most common approach for standalone businesses links the earn-out to a multiple of adjusted EBITDA. For example, a manufacturing business might structure an earn-out payment of 3x the amount by which EBITDA exceeds £1 million in the first year after acquisition.
Milestone-based earn-outs work well for businesses where specific achievements matter more than financial results alone. These might include regulatory approvals, product launches, or signing key clients. Specialist advice from Rubric Law can help structure these arrangements.
Hybrid structures blend multiple metrics for a more balanced approach. A healthcare tech company might combine revenue targets, new client wins, and regulatory approvals to trigger payments, capturing what actually drives value in their sector.
Legal and Commercial Considerations
The legal framework for an earn-out relies on clear, agreed definitions of financial metrics in the sale and purchase agreement. Both parties need to nail down in writing what “revenue” or “EBITDA” actually means, including which accounting standards you’re using.
This often means attaching example calculations or sample accounts to the agreement, showing exactly which items you’ll include or exclude. If a dispute comes up, your agreement will usually include arbitration clauses and name an independent accountant who can interpret the contract’s terms.
Transactions rely on detailed operating covenants written into the sale and purchase agreement. These set concrete standards for how the buyer must manage the acquired business during the earn-out period. Common covenants require the buyer to keep the business running in the ordinary course and not divert resources away from it.
Sellers often push for provisions that stop the buyer from cutting established marketing budgets below an agreed level or shifting shared costs across other group companies in ways that would artificially reduce the target’s earnings.
Problems With Earn-Outs and How to Avoid Them
Define Your Metrics Precisely or Pay the Price
Despite their benefits, earn-outs often lead to disputes over how performance gets measured. Vague metric definitions create confusion and disagreement between parties. For example, buyers and sellers might interpret revenue calculations differently depending on which accounting standards they’re using.
To prevent these issues, your agreement should spell out not just the targets, but also the exact calculation methods. Attach worked examples to show what you mean, and define key terms using recognised accounting policies that both (often based on UK GAAP or IFRS) parties have agreed on.
Protecting Your Payout When the Buyer Controls Operations
Another common problem involves weak operating covenants and a disconnect between earn-out criteria and business reality after the deal closes.
Without detailed requirements, a buyer could cut marketing spend or shift cost allocation in ways that make it harder for the seller to hit their targets, even if the business is genuinely performing well.
Strong agreements always include detailed operating covenants that set minimum standards for how the business gets managed. Sellers should push for clear provisions around marketing budgets, keeping resources in place, and fair allocation of costs during the earn-out period.
Before the deal closes, you need to set realistic targets based on a careful review of past performance and honest growth projections.
Making sure your earn-out metrics align with post-acquisition integration plans is essential to avoid the kind of friction that can damage trust between parties.
How Rubric Can Help
Getting expert advice means the deal actually reflects what both parties want while reducing the risk of disputes after you’ve closed.
Rubric Law works with both buyers and sellers, so we understand what matters on each side of the table. We can help you structure earn-outs that work for your specific situation and sector. That means drafting definitions that minimise the risk of disputes later, setting targets that make sense, and building in protections that actually hold up when you need them.
If you’d like to arrange a free consultation, please get in touch today.
FAQ Section
What percentage of the deal should an earn-out represent?
Earn-outs often make up a significant chunk of the deal, but the exact percentage varies quite a bit. It depends on your sector and how much leverage each side has in negotiations.
How can sellers protect themselves during the earn-out period?
Your best protection comes from detailed operating covenants written into the sale contract. These act as concrete rules that stop the buyer from making changes to the business that would sabotage your ability to hit your targets.
What happens if the business gets sold again before the earn-out period ends?
Without proper planning, a second sale can make your earn-out targets impossible to reach. That’s why most deals now include acceleration clauses that trigger partial or full payment of your remaining earn-out if the business changes hands again.
How are earn-outs taxed in the UK?
It depends on how you’ve structured the arrangement in your sale agreement and when payments become due. HMRC generally treats earn-out payments as capital gains if certain conditions are met, although the tax treatment depends on the structure of the earn-out and whether the consideration is ascertainable or unascertainable at completion. Specific tax advice should always be sought based on the circumstances of the transaction.
What causes most earn-out disputes?
Most disputes come down to unclear calculations and vague performance metrics. The agreements that avoid this problem include schedules with clear definitions tied to standards like UK GAAP, plus worked examples using sample accounts so everyone knows exactly what’s being measured.
