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Why earn-outs are used
When buyer and seller disagree on valuation — often because the seller believes near-term growth is achievable and the buyer is sceptical — an earn-out allows completion to proceed. The seller receives a guaranteed upfront payment and the opportunity to earn additional consideration if the business meets agreed targets. The buyer limits downside if the growth does not materialise.
Earn-outs are particularly common where the business is heavily dependent on the selling director's relationships, and the buyer wants to retain that director for a transition period.
How earn-out targets are structured
The earn-out metric is most commonly EBITDA or revenue over a defined period, measured against a pre-agreed schedule. The sale and purchase agreement must specify: the exact accounting policies used to calculate the metric; the treatment of any post-completion changes to the business (new products, acquisitions, cost cuts by the buyer); whether the seller has operational autonomy during the earn-out period; and audit rights over the buyer's earn-out calculation.
Vague drafting is the most common cause of earn-out disputes — sellers should insist on precision before signing.
Tax and accounting treatment
For the seller, earn-out proceeds are typically subject to capital gains tax in the year they are received or become unconditional, though the detailed position depends on deal structure and individual circumstances. If the earn-out is contingent on continued employment, HMRC may seek to treat some or all of it as employment income rather than a capital gain. Confirm the tax treatment with a corporate tax adviser before agreeing terms.
Protecting the seller during the earn-out period
Once the business is sold, the buyer controls day-to-day decisions. Without protective provisions, a buyer could artificially suppress EBITDA (by loading the business with central costs) or accelerate revenue recognition to front-load growth into a period after the earn-out ends. Sellers should negotiate specific protections: restrictions on inter-company cost allocations, a minimum operating budget, information rights, and a dispute resolution mechanism with a nominated independent expert.
Frequently asked questions
Can I walk away from an earn-out if the buyer makes unreasonable decisions post-completion?
Walking away typically forfeits any remaining earn-out entitlement unless the agreement contains specific leaver provisions or breach-of-covenant protections. The seller's best protection is a well-drafted SPA negotiated before completion — remedies after the fact are limited and expensive.
Are earn-outs common on all business sales?
Earn-outs are more common on deals where the business is growing rapidly, where the seller remains operationally involved post-sale, or where there is genuine disagreement on forward projections. On stable, mature businesses with clean accounts, buyers often prefer a clean break without contingent consideration.
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