Key takeaways

• An earn-out is a deferred, performance-based component of the purchase price. Payment depends on the company’s future performance.
• Earn-outs are often used when buyer and seller have different views of future performance and want to bridge the resulting valuation gap.
• The most common structure is a subsequent payment once agreed targets have been achieved. A partial sale with put and call options and a rollover investment are separate instruments, although both can be combined with an earn-out.
• Clear metrics, sufficient influence for the seller, appropriate protections, a suitable term and unambiguous calculation rules are critical.
• An earn-out can increase the total purchase price, but only if the targets are realistic and the contractual framework is robust.

What is an earn-out?

An earn-out is a portion of the purchase price that is not paid in full at closing. The subsequent payment depends on the company’s performance or the achievement of defined targets, such as a specified level of revenue or recurring revenue, EBIT or EBITDA, the retention of key customers, a target margin, or operational and technological milestones.

An earn-out therefore combines two elements: a fixed purchase price paid at closing and a variable purchase price component that may become payable at a later date.

Why are earn-outs used?

Earn-outs are often used when buyer and seller have different expectations regarding the company’s future performance and want to bridge the resulting valuation gap.

The seller may expect strong growth and derive a higher valuation from that outlook. The buyer may take a more cautious view and initially be prepared to pay only a lower fixed purchase price. An earn-out allows part of this difference in expectations to be reflected in the transaction structure.

The seller has the opportunity to receive a higher total consideration if the business performs as expected. The buyer reduces risk because part of the purchase price becomes payable only if the agreed performance is delivered.

Our article on the process of selling a business explains the wider transaction process.

How does an earn-out work?

A simple example illustrates the mechanics:
At closing, the buyer pays a fixed purchase price of EUR 8 million. The seller may receive an additional amount of up to EUR 2 million, depending on whether the company reaches specified EBITDA targets over the following two years. If the targets are only partially achieved, the variable consideration is reduced accordingly, provided this has been agreed in the purchase agreement.

The calculation methodology should be set out in the purchase agreement. This includes the relevant metric, the measurement period, thresholds, any cap and the applicable accounting rules.

An earn-out is therefore not only an economic mechanism but also a matter of contractual design. Ambiguous drafting frequently leads to different interpretations and disputes between the parties.

Which earn-out and participation structures are used?

Three structures are particularly relevant in practice. Only the first is an earn-out in the strict sense; the other two are participation models that may be used as alternatives or in combination:

1. Performance-based deferred consideration

Under a conventional earn-out, the seller receives a subsequent payment if the company meets defined targets.

Potential targets include:

• revenue or recurring revenue,
• EBIT or EBITDA,
• operating margin,
• number of active customers,
• customer retention or contract renewals,
• product, technology or integration milestones.

This structure is particularly suitable where the parties can assess performance using clear and measurable criteria.

2. Partial sale with put and call options

A partial sale with put and call options is not an earn-out in the strict sense. The seller initially disposes of only part of the shareholding and remains invested as a shareholder. This allows the seller to participate in future value creation and continue contributing to the company’s development.

The parties may agree put or call options for the later sale of the remaining interest:

A put option allows the seller to sell the remaining interest on agreed terms.

A call option allows the buyer to acquire the remaining interest on agreed terms.

Alternatively, the parties may agree a drag-along right. If the company is subsequently sold in full, the remaining shareholders must sell their interests on the agreed terms. This can provide a future route to liquidity for the retained shares even without a put option.

3. Rollover investment in the acquiring company

In a rollover, the seller reinvests part of the sale proceeds in the acquiring company or its holding company. The buyer may therefore acquire 100 per cent of the target while the seller receives an interest in the wider acquiring group.

This structure is particularly common in transactions involving financial sponsors. It aligns the parties around the group’s future value creation and may also support the financing of the acquisition. The seller realises a further return when the acquiring company or holding company is sold at a later stage.

Under an earn-out, a later payment becomes due once defined targets are met. It can bridge a valuation gap and reflect future performance in the purchase price. In a partial sale, the seller remains directly invested in the target. In a rollover, the interest is transferred into the acquiring company or a holding company. Partial sales and rollovers can be combined with an earn-out, but they remain distinct instruments.

When does an earn-out make sense?

An earn-out may be appropriate where several of the following conditions apply:

• The seller expects stronger business performance than the buyer.
• The valuation depends heavily on future growth or earnings targets.
• The seller remains involved in an operational or advisory capacity after closing.
• Performance can be measured using objective criteria.
• The buyer has an economic interest in continuing to develop the company successfully.
• Both parties are prepared to agree the calculation methodology and operating rules in sufficient detail.

A seller seeking to exit completely at closing and secure the entire purchase price immediately may be better served by an all-cash structure. An earn-out transfers part of the risk to the seller and extends the seller’s economic exposure to the business.

Key criteria for a fair earn-out

1. The seller must be able to influence performance

An earn-out only makes sense if the seller can materially influence the agreed targets during the earn-out period. Where the existing management team remains in place, it should retain sufficient operational authority. If the company is integrated immediately, important parameters may change, including cost allocation, revenue attribution, product and sales strategy, the closure or transfer of business units and the prioritisation of customers and markets.

The seller should not be held to targets that can no longer be influenced. If integration is planned, the parties should agree in advance how it will affect the earn-out calculation.

2. The relevant metric must be defined precisely

Terms such as revenue, EBIT and EBITDA are not automatically unambiguous. The agreement should specify how the relevant metric is calculated and which accounting principles apply.

Questions to address include:

• Are acquisitions or disposals of business units included?
• How are foreign-exchange effects treated?
• How are one-off expenses and exceptional items defined?
• Which costs may be allocated to the company?
• How are intra-group services and transfer pricing treated?
• How are changes in accounting policies handled?
• How is revenue from new products or customer groups included?

The greater the discretion around these issues, the higher the risk of future disputes.

3. Protections should prevent unilateral interference

Following closing, the buyer controls the company and can take decisions that affect the earn-out. Protective provisions are intended to prevent the variable consideration from being economically undermined by unilateral measures.

Potential protections include:

• consent rights for material changes to the business model,
• rules governing the allocation of costs and revenue,
• information and reporting obligations,
• access to the underlying calculation,
• review by an independent auditor,
• adjustment mechanisms for acquisitions, integrations or restructurings,
• accelerated payment where structural changes make meaningful measurement impossible.

Protections should not be drafted only in general terms. The more specifically the relevant actions are addressed, the lower the risk of dispute.

4. The parties’ economic interests should be aligned

An earn-out works particularly well when the buyer benefits economically from the achievement of the targets and the resulting payment.

Example: the acquiring company is valued by the market at 15 times EBITDA, while the earn-out pays the seller 10 times the incremental EBITDA generated. Under these assumptions, each additional contribution to earnings may create more value for the buyer than the corresponding earn-out payment.

This is a simplified example. Whether an earn-out is genuinely value-accretive depends on the sustainability of the earnings, the integration and the valuation environment. The underlying principle remains important: the buyer should not have an economic incentive to prevent the targets from being achieved.

5. The term should reflect the company’s development cycle

A term of one to three years is practical in many transactions. It provides enough time to measure growth or earnings targets without binding the parties to an uncertain plan for too long. A longer term may be appropriate where sales cycles are particularly long, new products will generate revenue only at a later stage, regulatory approvals are outstanding or performance depends on a multi-year customer contract.

Uncertainty increases with the length of the earn-out period. Business models, market conditions, management teams and accounting policies may change. Any longer term should therefore be justified by the circumstances and supported by appropriate adjustment mechanisms.

6. Staged settlement can reduce risk

Instead of calculating the entire earn-out only at the end of the term, the parties may agree several measurement periods and partial payments.

This offers several advantages:

• The seller receives earlier clarity on payments.
• One weak financial year does not determine the entire earn-out.
• The buyer can review performance regularly.
• The parties can identify earlier whether the calculation or operational implementation needs to be adjusted.

Whether staged settlement is appropriate depends on the business model and the agreed metric.

Which metric is suitable for an earn-out?

The appropriate metric depends on the business model, transaction structure and the seller’s ability to influence performance. There is no single measure that is best in every situation.

Metric	Advantage	Potential challenge
Revenue	Easy to understand and generally transparent	Revenue may grow at the expense of margin or through less profitable business
EBIT	Includes depreciation and amortisation	Investment levels and depreciation policies may affect comparability
EBITDA	Closer to operating performance and widely used in transactions	Adjustments and cost allocations may create room for interpretation
Recurring revenue, such as ARR	Suitable for subscription and SaaS models	Recurring revenue, churn and new customer definitions must be precise
Operational or technology milestones	Suitable for products with longer development cycles	Achievement must be objectively verifiable

Revenue or recurring revenue may be appropriate in sectors such as Software and TMT, where revenue multiples are commonly used. EBITDA may be more meaningful for other business models. The key is that the metric reflects the company’s economic development and remains reasonably within the seller’s influence.

What should an earn-out agreement cover?

An earn-out should not be described by a target figure alone. The purchase agreement should address at least the following points:

• Measurement period: Which months or financial years are included?
• Metric: Which measure is decisive?
• Baseline: From which level is performance measured?
• Thresholds: At what level does a payment entitlement arise?
• Graduation: How does the payment change if targets are only partially achieved?
• Cap: Is there a maximum amount of deferred consideration?
• Calculation: Which accounting rules and adjustments apply?
• Operational management: Which decisions may the buyer take without triggering an adjustment?
• Information rights: Which reports and documents will the seller receive?
• Audit rights: How may the calculation be reviewed?
• Departure: What happens in the event of resignation, dismissal, illness, death or a change in management?
• Structural changes: How are integrations, acquisitions, disposals and restructurings treated?
• Dispute resolution: Who decides if the parties disagree on the calculation?
• Acceleration: When does the earn-out become payable before the end of the term?

Additional provisions may be required depending on the transaction. The specific structure should be reviewed from both a legal and tax perspective.

What role does management play in an earn-out?

An earn-out does not automatically require the existing management team to remain with the company. Whether continued involvement is necessary depends on the target structure. If performance depends materially on the existing management team, its role during the earn-out period should be defined clearly, including responsibilities, operational decision-making authority, reporting lines, remuneration and incentives, termination and severance arrangements, and the consequences of a voluntary or involuntary departure.

Where an earn-out is based solely on objective metrics that are largely independent of the former management team, continued involvement may be less important. Even then, the agreement should specify what happens if a key manager leaves before the end of the earn-out period.

Earn-outs and management equity are not the same

Management equity or a rollover can allow management to participate in future value creation. These instruments should be distinguished from an earn-out.

Under an earn-out, the seller receives a later payment if defined targets are achieved.

Under a management equity plan, management receives shares or other participation instruments.

Under a rollover, the seller reinvests part of the sale proceeds and retains an equity interest.

These instruments can be combined, but they should be presented separately in the agreement and in communications with management.

Earn-out benefits and risks at a glance

Benefits for the seller

• Potential for a higher total purchase price,
• bridging different price expectations,
• participation in the value of expected growth,
• stronger support for a higher valuation where the outlook is well substantiated.

Benefits for the buyer

• Lower payment at closing,
• part of the purchase price depends on actual performance,
• alignment of buyer and seller interests,
• the ability to incentivise specific growth, earnings or integration objectives.

Risks for the seller

• Part of the purchase price remains uncertain,
• the buyer can influence operational performance,
• different interpretations of the calculation may lead to disputes,
• the seller remains economically and often operationally involved for longer,
• changes in the market or the company may make the targets harder to achieve.

Risks for the buyer

• The buyer must make an additional payment if the targets are achieved,
• ambiguous definitions may lead to disputes and additional costs,
• an overly complex earn-out may hinder integration,
• heavy reliance on the existing management team may constrain implementation.

Is an earn-out right for your situation?

An earn-out may be the right structure where the seller believes in the company’s future performance and can realistically influence it. It may be less suitable where the seller intends to leave completely at closing or where performance depends heavily on factors beyond either party’s control.

The following questions provide an initial framework:

• How large is the valuation gap between buyer and seller?
• Which targets should trigger the contingent consideration?
• Can the seller still influence those targets after closing?
• Which decisions will be controlled solely by the buyer?
• Can revenue, earnings or other milestones be measured objectively?
• Which protections are required?
• How long should the seller remain economically or operationally involved?

Conclusion: earn-outs require clear rules

An earn-out can bridge a valuation gap and give the seller the opportunity to achieve a higher total purchase price. At the same time, part of the consideration remains dependent on future business performance.

Clear rules matter more than broad promises. The metric must be transparent, the seller should retain sufficient influence and the buyer should not be able to impair performance unilaterally. Equally important are clear calculation, information and dispute-resolution provisions.

An earn-out is therefore neither automatically the best solution nor an instrument to avoid in principle. It works well when it fits the company’s development, the seller’s role and the economic interests of both parties.

Frequently asked questions about earn-outs

What is an earn-out?

An earn-out is a performance-based component of the purchase price. It is not paid in full at closing but depends on the company’s subsequent performance or the achievement of defined targets.

Why is an earn-out used?

An earn-out is often used when buyer and seller have different expectations regarding future performance. The subsequent payment can help bridge the resulting valuation gap.

When does an earn-out make sense for the seller?

An earn-out may be appropriate where the seller believes in future growth, can still influence performance and is prepared to remain economically or operationally involved. A seller seeking full payment and a complete exit at closing may be better served by an all-cash structure.

How long does an earn-out typically last?

Many earn-outs run for one to three years. A longer period may be appropriate for long sales cycles, multi-year customer contracts or delayed product and technology milestones. Longer periods, however, increase uncertainty and the need for detailed provisions.

Which metric is suitable for an earn-out?

The appropriate metric depends on the business model. Revenue, EBIT and EBITDA are common. For software companies, recurring revenue such as ARR, customer retention or product milestones may also be suitable. The metric should be clearly defined, objectively measurable and reasonably within the seller’s influence.

What risks does an earn-out create for the seller?

The main disadvantage is that part of the purchase price remains uncertain. The buyer may also take decisions after closing that affect performance. Without clear calculation rules and protections, disputes may arise over the amount payable.

What is the difference between an earn-out, a partial sale and a rollover?

Under an earn-out, the seller receives a later payment if defined targets are achieved. In a partial sale, the seller initially disposes of only part of the shareholding and remains directly invested in the target company. In a rollover, the seller reinvests part of the sale proceeds in the acquiring company or a holding company. Partial sales and rollovers can be combined with an earn-out but are economically distinct instruments.

Must management remain during the earn-out period?

Not necessarily. Continued involvement may be advisable or required where performance depends materially on the existing management team. The agreement should define management’s role and the consequences of an early departure.

What should an earn-out agreement cover?

The agreement should address the metric, measurement period, thresholds, calculation method, maximum payment, information and audit rights, and the treatment of integrations, acquisitions, restructurings and an early departure.