When a buyer and a seller can’t quite agree on what a company is worth today, they often turn to an earn-out. In simple terms, an earn-out ties part of the purchase price to the business’s future performance—usually revenue or profit targets—over a set number of years.
That structure can feel like a handshake that says, “Prove it, and I’ll pay.” While earn-outs can smooth negotiations, they also carry real risks. Understanding both sides of the ledger helps owners decide whether this deal sweetener is worth the extra complexity.
What an Earn-Out Really Means
An earn-out inserts a deferred payment schedule into the sale agreement, splitting the price into an upfront sum and later installments triggered by performance milestones. For instance, a buyer might pay 70 percent at closing and the remaining 30 percent if EBITDA hits the agreed-upon targets over the next three years.
On paper, that sounds straightforward, but the devil is in the definitions: which accounting standards apply, how revenue is recognized, and who controls key spending decisions after the sale. Because those details determine whether targets are met, drafting the earn-out language with extreme clarity is essential.
Upsides: Bridging Gaps and Aligning Goals
The biggest advantage of an earn-out is its power to bridge valuation gaps. Sellers who believe their brand is poised for rapid growth can “prove” that upside rather than accept a lower all-cash offer. Buyers, meanwhile, limit their risk by paying full price only if the hoped-for growth materializes.
Earn-outs also keep departing owners and key managers engaged, often requiring them to stay on in advisory roles to steer the company toward its targets. That continuity can boost morale, retain customers, and maintain momentum during a vulnerable transition period—all while signaling to employees that leadership still has skin in the game.
Downsides: Delays, Disputes, and Opportunity Costs
Earn-outs are famously fertile ground for post-closing disputes. Buyers might fold the acquired firm into a larger unit, shift expenses, or change sales strategies, any of which can dent short-term earnings and jeopardize an earn-out payment. Even with the best intentions, economic swings or supply-chain shocks can make reasonable targets suddenly unreachable.
Meanwhile, sellers effectively finance part of the deal interest-free and live with years of uncertainty about when—or whether—they’ll see the rest of their money. Legal fees, strained relationships, and distracted management teams are common by-products when actual results start diverging from rosy projections.
Making Earn-Outs Work: Practical Safeguards
If you decide that an earn-out is the right route for selling your business, build guardrails early. First, choose performance metrics that are as tamper-proof as possible—top-line revenue is often simpler than profit, which can be massaged with accounting moves. Second, outline in writing who controls budgeting, hiring, and major strategic pivots during the earn-out period, and consider carve-outs that adjust targets if market-wide shocks strike.
Third, negotiate dispute-resolution mechanisms upfront, such as appointing a neutral accountant whose judgment is binding. Finally, cap the earn-out period: three years is common, five is pushing it, and anything longer can turn a straightforward exit into an endless engagement.
Conclusion
Earn-outs can be a creative way to unlock deals that would otherwise stall, rewarding both sides if the business thrives after the handover. Yet they also introduce complexity, prolong risk, and create fertile ground for conflict. Sellers must weigh the lure of a higher overall price against the certainty and freedom that come with an all-cash exit, while buyers should assess whether the future performance they’re banking on is truly within reach.
With clear metrics, solid legal drafting, and realistic expectations, an earn-out can turn mutual doubt into mutual gain—but only if both parties remain partners long enough to see the final payment cross the finish line.
