Earn-outs: when part of the price is paid later

How common they are, and how often they pay

According to SRS Acquiom, which administers payments on thousands of private deals, 24% of private-company acquisitions outside life sciences included an earn-out in 2025, up from 19% in 2014. Its research also finds that across deals with an earn-out, only about one dollar in five of the potential earn-out is eventually paid. That figure covers many sectors and deal types, and well-drafted earn-outs in steady businesses pay out far more often. But it explains why a buyer will happily add a generous earn-out to an offer, and why you should value it well below its face amount.

When an earn-out makes sense

• Recent growth: profits jumped last year and the buyer is not yet convinced it will last.
• A new contract or product: signed but not yet showing in the accounts.
• Customer concentration: one large customer the buyer fears losing.
• A gap in price that nothing else closes: both sides want the deal but are a few million dollars apart.

It makes less sense when you will not be running the business after closing, when the buyer plans to merge your company into its own (making your results hard to measure), or when the targets depend on decisions the buyer controls.

How it works

1. Agree the base price paid at closing.
2. Choose the measure: usually revenue, gross profit or EBITDA, sometimes a non-financial milestone such as renewing a key contract.
3. Set the targets and the period: for example, EBITDA of $4.6 million in year one and $5.0 million in year two.
4. Set how the payment scales: all-or-nothing (a cliff), or a sliding scale between a floor and a cap. Sliding scales are fairer to sellers.
5. Fix the accounting rules used to measure results, and how disagreements are settled.
6. The buyer measures, reports and pays after each period, and you check the numbers.

A worked example

Our illustrative company has $4.0 million of EBITDA. The owner has just signed a three-year contract with a new customer that should add about $1 million of EBITDA a year, and believes the company is worth $28 million. The buyer, unsure the contract will deliver, offers $24 million. They agree on $22 million at closing plus up to $5 million of earn-out: $2.5 million if EBITDA reaches $4.6 million in year one, and $2.5 million more if it reaches $5.0 million in year two, scaled down proportionally for results between $4.0 million and the target.

Compared with a straight $24 million offer, the owner gains $3 million if the contract performs and loses $2 million if it does not. Whether that trade is worth it depends on how confident the owner is in the contract, and on whether the protections below are in place. Figures are illustrative and before tax.

The terms that protect the seller

Most earn-out disputes come from how results are measured and from decisions the buyer makes after closing. These are the points to negotiate:

• Pick a measure the buyer cannot easily move. Revenue or gross profit is harder to influence through cost allocations than EBITDA. If EBITDA is used, exclude the buyer's management fees, integration costs and new overheads.
• Freeze the accounting. Results are measured using the company's existing accounting policies, written into the agreement.
• Operating commitments. The buyer runs the business consistently with past practice, keeps it as a separate unit with its own accounts, and does not starve it of staff, budget or sales effort needed to hit the targets.
• Sliding scales and catch-ups. Partial payment for partial performance, and the ability to make up a shortfall in year one with a strong year two.
• Acceleration. The full earn-out becomes payable if the buyer sells the business, merges it so results can no longer be measured, or dismisses you without cause.
• Information and audit rights. Monthly results, and the right to have an independent accountant check the calculation.
• Dispute resolution. A named independent accounting firm decides on disputed numbers quickly, rather than litigation.
• Limits on set-off. The buyer should not be able to withhold earn-out payments to cover unrelated claims without due process.
• Security. For a smaller or highly leveraged buyer, a parent guarantee or escrow for the earn-out.
• Keep it short. One to two years is easier to forecast and to protect than three or more.

Tax points to raise with your advisor

This is not tax advice. Questions for your tax advisor:

• An earn-out is normally treated as part of the purchase price, taxed as capital gain, with installment reporting possible as payments arrive.
• If payment depends on you continuing to work for the buyer, the IRS may treat it as compensation, taxed as ordinary income at higher rates. How the earn-out is drafted matters.
• Part of each deferred payment may be treated as interest.
• State tax residence at the time each payment is received can matter.

How ExitBuy helps

The best protection against a weak earn-out is not needing one: a well-prepared company sold in a competitive process gives buyers less reason to defer part of the price. When an earn-out is the right tool, we model what it is realistically worth, compare it with offers paying more at closing, and negotiate the measure, accounting rules and protections above before you are locked into exclusivity.

Frequently asked questions

Mauro Terrinoni, CFA, founder of ExitBuy Co. 25 years in investment banking and private equity, including at JP Morgan, Citigroup and Fortress Investment Group, and has bought, run and sold a company as its owner.

General information only, not investment, legal or tax advice. Figures are illustrative. Tax rules change; confirm current law with your own advisors.

Sources: SRS Acquiom, Earnout and Milestone Trends in Private-Target M&A Deals