What is an earn out and should I accept one?
How earn outs work, why buyers ask for them, and the terms that decide whether you actually get paid. Plus when an earn out is the right answer.
General information only, not financial, legal or taxation advice. Tony Pope holds Queensland Office of Fair Trading licence 4963575.
The short version
- An earn out defers part of the price and makes it conditional on the business hitting agreed targets after settlement.
- Treat the deferred portion as at risk, not as part of the price. Decide whether the certain money alone is enough.
- The measure matters more than the number. Earn outs tied to revenue are harder to manipulate than earn outs tied to profit.
- Whoever controls the business after settlement controls the outcome, so the protections in the contract are the whole negotiation.
An earn out is a deferred, conditional part of the price. Some of the money is paid at settlement, and the rest becomes payable later if the business hits agreed targets, usually over one to three years.
Sellers often hear the headline number and stop listening. The number that matters is the part you receive regardless.
Why buyers ask for one
Usually for one of three reasons, and they are worth distinguishing because they call for different responses.
Genuine uncertainty. The business had an unusual year, a large contract is up for renewal, or a lot of the value sits in relationships that may or may not transfer. The buyer is not being difficult, they are pricing a real unknown.
Funding. They cannot raise the full amount at settlement and the earn out closes the gap. This one is worth knowing about, because it tells you something about their capacity to complete at all.
A price gap. You want a number, they will pay less, and the earn out bridges the difference on paper without either side moving. This is the most common version and the most dangerous, because it can look like agreement when it is not.
The risk is not symmetrical
Once settlement happens, the buyer runs the business. They set the pricing, the wages, the marketing spend, the overhead allocation and the accounting policies. Every one of those affects whether your target is hit.
I am not suggesting most buyers set out to avoid paying. Most do not. But businesses change after settlement even with good intentions. A buyer who folds your operation into theirs, moves your work onto their systems, or reallocates management cost across the group can hit your earn out target without ever meaning to.
That is why the contract terms carry more weight than the headline figure.
What decides whether you get paid
The measure. Revenue is hardest to manipulate and easiest to verify. Gross profit is workable. Net profit or EBITDA gives the buyer the most levers, because overhead allocation, management fees, director wages and depreciation policy all sit on their side of the line. If the measure is profit based, the definition needs to be written out in detail, including what cannot be charged against it.
Who prepares the numbers. Whoever does the accounting has enormous influence. Build in your right to see the workings, to have your accountant review them at your cost, and to a defined dispute process with an independent expert rather than litigation.
Protective covenants. Written commitments about how the business will be run during the period. No stripping the marketing budget, no moving customers to a related entity, no loading unrelated overhead onto the accounts, no closing the division your target depends on. Without these you are relying on goodwill.
Acceleration triggers. If the buyer sells the business, restructures it, terminates your involvement or breaches the covenants, the remaining earn out should become immediately payable. This is standard and worth insisting on.
Security. An unsecured promise from a company with no assets is worth what it sounds like. Consider a bank guarantee, a charge, a holding of shares, or funds in a controlled account. Ask what stands behind the promise.
The test I would apply
Ignore the total. Ask whether the money you receive at settlement, on its own, is a price you would accept for the business.
If it is, the earn out is upside and you can approach it calmly.
If it is not, then you are not being offered that price. You are being offered a lower price with a chance attached, and you should negotiate the certain portion up rather than the conditional portion.
When an earn out is genuinely the right answer
They are not a trap by nature and they solve real problems.
If you are staying on for a transition with actual influence over the result, an earn out can align both sides properly and get you paid for a handover you were doing anyway.
If the business genuinely does have an uncertain element, an earn out can get a deal done that a fixed price would have killed, and it can pay you more than a discounted certain price would have.
If a buyer's caution is the only obstacle and you believe in the numbers, taking some risk to prove them can be the right commercial call.
Before you sign
This is contract territory and it belongs with your solicitor, and the tax treatment of deferred consideration belongs with your accountant. Neither of those is a broker's job, and any broker telling you an earn out is "standard, do not worry about it" is not doing you a service.
What a broker should do is make sure the certain portion is negotiated as hard as the headline, because that is the part you can count on.
Common questions
How does an earn out work in a business sale?
Part of the purchase price is paid at settlement and the rest becomes payable later if the business meets agreed targets, usually measured over one to three years. The targets are commonly revenue, gross profit or EBITDA, and the terms set out how they are measured, who prepares the accounts and what happens if there is a dispute.
Are earn outs a bad idea for sellers?
Not inherently, but the risk sits almost entirely with the seller because the buyer controls the business during the earn out period. They work best where you are staying involved with real influence, where the measure is hard to manipulate, and where the certain portion of the price is already acceptable on its own.
What percentage of the price should be an earn out?
There is no standard, and the right answer depends on what you are prepared to put at risk. The more useful test is not the percentage but whether you would still do the deal if the earn out paid nothing. If the answer is no, the certain portion is too low.
Keep reading
All notes on selling a business · All seller guides · What is my business worth?
Check it yourself
Primary sources, none of them affiliated with me and none of them endorsing this site. Where anything here differs from an official source, the official source is right.
Links open on external government and industry websites. The full list sits on licensing, registers and official sources.
Ask what it is worth
Free, in writing, and nobody finds out you asked. Tell me the trade and the suburb and I will do the rest.
Nobody finds out you are selling. This goes to me only, into my own database in Sydney. I will not contact your accountant, your landlord, your bank or your staff, ever, unless you ask me to.
If you would rather not put anything in writing yet, ring 0431 124 128. Prefer to pick a time yourself? Book a time in my diary.
Thinking about selling?
Thirty minutes, on the phone or in person, at a time that suits you including evenings. You will get a straight read on where the business sits today and what would move the number. It costs nothing, there is no obligation, and nobody finds out you asked.