Earn-out, explained simply
Where buyer and seller disagree on future performance, an earn-out bridges the gap: the seller is paid more only if the results arrive. Typical features are a metric, a period of one to three years, a payout formula (all-or-nothing or sliding) and a cap.
Earn-outs are among the most disputed provisions. Definitions of the metric, the costs allocated to the business and the seller’s influence after closing should be precise.
Earn-out payable against FY2027 EBITDA
IllustrativeAlder Creek Manufacturing, $ millions
At EBITDA of $5.0 million the seller receives $2.0 million of the $4.0 million maximum.
Worked example
| FY2027 EBITDA | Earn-out paid |
|---|---|
| Below $4.8 million | $0 |
| $4.8 to $5.2 million | Scales from $0 to $4.0 million |
| $5.2 million or more | $4.0 million |
FY2027 EBITDA is $5.0 million, so the seller receives $2.0 million.
Alder Creek Manufacturing, Inc. is a fictional company. All figures are illustrative.
Where disputes arise
- How EBITDA is calculated after integration with the buyer
- Costs the buyer allocates to the business
- Changes the buyer makes that affect results
- The seller’s role and control after closing
Why it matters in a deal
Earn-outs can close a valuation gap, but precise definitions, often following the QoE methodology, are needed to avoid disputes.
Red flags
- Vague metric definitions
- A large share of the price contingent on optimistic targets
- The seller having no influence over results after closing