Where the money actually moves

An earn-out defers part of the purchase price against performance the seller no longer controls. The buyer runs the business from completion; the seller carries the consequences for another one to three years. That asymmetry is not a flaw in the structure — it is the structure. Nearly every earn-out dispute we have run turns on it.

Sellers accept earn-outs because they bridge a valuation gap. The buyer will not pay today for growth it has not seen; the seller will not sell at a price that ignores the pipeline. Deferring part of the consideration lets both sides sign a deal that would otherwise die over a multiple. What neither side tends to price properly is who holds the levers during the period that decides the number.

The three clauses that decide it

The first is the accounting policy schedule. “Prepared on a basis consistent with past practice” is not a policy — it is an invitation to argue eighteen months later. Specify revenue recognition, the treatment of work in progress, provisioning policy, and whether group recharges are permitted. If the target has never prepared audited accounts, say which standard applies and who signs them.

The second is the conduct covenant. It should state positively what the buyer will do — maintain the sales team at agreed headcount, keep the brand in market, fund working capital to a stated level — and negatively what it will not do without consent: restructure the division, reallocate customers to a sister company, change the financial year end, or push central costs down from the parent.

The third is the dispute mechanism. Name an expert or a class of expert, fix the timetable, and say who bears the cost. A clause that sends the parties to “an independent accountant to be agreed” has, in practice, no mechanism at all. It has a second negotiation, conducted at the worst possible moment, between parties who by then trust each other very little.

Where it goes wrong in practice

The most common failure is not bad faith. It is an acquirer integrating a business the way any sensible acquirer would — consolidating the back office, migrating the target onto group systems, retiring an overlapping product line — and in doing so making the earn-out unreachable. The seller sees deliberate value destruction. The buyer sees ordinary post-completion management. Both are describing the same facts, which is why these matters settle late and expensively.

The second failure is measurement. EBITDA is not a defined term with a fixed meaning. It is whatever the schedule says it is, and where the schedule is thin the buyer’s accountants will apply group policy while the seller’s apply the policy the business used before completion. The gap between those two numbers is often larger than the earn-out itself.

The third is silence. Many earn-outs give the seller no visibility at all until the final statement lands. By then the period is closed, the decisions are made, and the only available remedy is litigation over events the seller could not see.

What we ask before signing

Who prepares the earn-out accounts, and who reviews them? What happens if the buyer restructures the division, or sells it on mid-period? Is there a floor, or acceleration on a change of control? Can the seller see management accounts monthly, or only the final statement? Is the target ring-fenced, and if so how tightly?

Most sellers can answer none of these on the day the term sheet lands — which is precisely when the answers are cheapest to obtain. Once heads of terms are signed the commercial momentum runs against reopening the mechanics, and the seller is negotiating detail against a counterparty who now has an agreed price.

A workable position

A well-drafted earn-out is not one that protects the seller against every eventuality. That deal does not exist, and pursuing it usually costs the seller the transaction. It is one where both parties know, before signing, what happens in the three or four scenarios that are actually likely: integration, underperformance, a change of control, and a disagreement about the accounts.

Where those four are addressed in the document, earn-outs work. Where they are not, the parties are relying on goodwill to survive a period specifically designed to test it.