A deferred payment mechanism in a company acquisition where part of the purchase price is contingent on the business achieving specified targets after closing.
In many business acquisitions, buyer and seller cannot agree on the value of the company. The seller believes their business is worth more than the buyer is willing to pay. The earn-out was created precisely to bridge that gap: it is a mechanism that connects two different views of the company’s future.
An earn-out is a contractual clause included in the sale and purchase agreement (SPA) that stipulates a portion of the acquisition price will be paid to the seller on a deferred basis, conditional on the achievement of specified financial or operational targets during a period after closing.
In simple terms: the buyer pays part of the price at closing (the fixed price) and commits to paying an additional amount (the earn-out) if the company meets certain milestones in the following years.
The most common objectives used to structure an earn-out are:
The earn-out period usually ranges from one to three years after closing, although in complex transactions it can extend to five years.
The earn-out is one of the most powerful negotiation tools in M&A, but also one of the most contentious. Understanding its implications is essential for both parties.
For the seller, the earn-out can be the difference between closing the deal and walking away. If the buyer is unwilling to pay the valuation the seller considers fair based solely on historical results, the earn-out allows the seller to bet on the future of their company: if the results materialise, they receive the full price they expected.
For the buyer, the earn-out is a protection mechanism. By making part of the price contingent on future results, risk is reduced: the variable component is only disbursed if the company demonstrates it is worth what the seller claimed. It also aligns the seller’s incentives with company performance during the transition period.
The main risk lies in post-closing execution. Once the deal closes, the buyer controls the company. Management decisions they make — investments, hiring, strategy changes — can directly affect whether the earn-out targets are met. This creates a potential conflict of interest that must be regulated meticulously in the contract.
A poorly designed earn-out is an almost guaranteed source of legal disputes. To avoid this, attention must be paid to these elements:
Clear and unambiguous metrics. Variables must be defined with accounting precision. “EBITDA” can mean different things depending on the adjustments applied. The SPA must detail exactly how each metric is calculated.
Protection against manipulation. The seller should negotiate clauses preventing the buyer from making artificial decisions that reduce the earn-out indicators (for example, accelerating expenses, deferring revenues, or loading corporate costs onto the acquired subsidiary).
Ordinary course of business obligation. The buyer must commit to managing the company consistently with pre-closing practice, without substantial changes that distort results.
Review and audit mechanism. The seller must have the right to review the accounts and to submit any discrepancy to an independent auditor or arbitration mechanism.
Graduated scale. A graduated earn-out is preferable (for example, X% if 90% of the target is reached, 100% at target, 120% if exceeded) rather than a binary all-or-nothing mechanism.
A technology company in southern Spain specialising in logistics management software has 8 million euros in revenue and 1.5 million EBITDA. The seller wants 12 million (8x EBITDA). The buyer, a family office, values the company at 9 million (6x EBITDA) because they believe recent growth may not be sustainable.
They agree on the following structure:
At the end of the second year, average EBITDA has been 1.7 million. The seller receives the additional 1.5 million (the second tier is not reached). The total transaction price has been 10.5 million — a midpoint between the two initial valuations.
It depends on your confidence in the business’s future projections and the degree of control you will maintain over management after closing. If you firmly believe the company will continue to grow and you negotiate adequate contractual protections, the earn-out can allow you to achieve a higher total price than you would without it. But if you will have no influence over management decisions, you are taking on a significant risk of not receiving the variable component.
Usually, the earn-out accounts for 15% to 35% of the estimated total price. Percentages above 40% are a warning sign: they mean too large a portion of the price depends on factors the seller will not fully control. In the Spanish mid-market, standard practice places the earn-out at around 20-25% of the total transaction value.
This is one of the most common sources of litigation in M&A. That is why the SPA must include a dispute resolution mechanism: first, a good-faith negotiation period between the parties; second, intervention by a pre-designated independent auditor; and third, binding arbitration if the disagreement persists. The cost of including these clauses is minimal compared to the cost of subsequent litigation.
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