Understanding Earn-Outs in Business Sales

When selling a business, one of the most important aspects to understand—yet one of the most often misunderstood—is the concept of an earn-out. For many UK business owners, an earn-out can be the key to securing a higher overall sale value, but it can also be a source of uncertainty and risk if not properly structured. In this guide, we’ll explore everything you need to know about earn-outs: what they are, how they work, their pros and cons, and how to ensure they’re structured in your favour.

What is an Earn-Out?

An earn-out is a contractual agreement in which a portion of the sale price is paid out after completion, contingent on the business achieving specific future performance targets. These targets are typically linked to financial measures such as revenue, EBITDA, gross profit, or net income, although operational or strategic milestones can also be used in certain situations.

The structure of an earn-out means that the buyer pays an agreed portion of the consideration upfront, giving the seller an immediate return. The remaining balance—sometimes a significant percentage of the total sale price—is deferred and contingent on the business meeting performance targets during a defined period, usually between one and three years post-completion. This mechanism helps bridge valuation differences, particularly in cases where the seller sees more future value in the business than the buyer is willing to pay for upfront.

Earn-outs are also used to keep the seller engaged in the business during the transition, especially if the seller remains in a leadership or advisory role. In such cases, the seller can directly influence performance and earn-out outcomes, aligning both parties’ interests through shared accountability for the business’s ongoing success.

Why Are Earn-Outs Used?

Earn-outs serve as a mechanism to bridge valuation gaps between sellers and buyers, particularly when there’s a difference in perspective around the future performance or value of the business. They help ensure that the final sale price is aligned with actual business outcomes, rather than predictions or assumptions made at the time of sale.

They are most commonly used when:

• The buyer is unsure about the future performance of the business. This could be due to a lack of historical data, volatile market conditions, or new products/services still in early growth stages. An earn-out reduces the buyer’s risk by tying part of the price to the business achieving its projections.
• The business is experiencing rapid growth or undergoing significant change. A business on an upward trajectory may be hard to value with confidence. Earn-outs allow the seller to benefit from future growth, while the buyer limits their initial exposure.
• The seller has high expectations, but the buyer wants assurances that those expectations will be met. When there’s a gap between what the seller believes the business is worth and what the buyer is willing to pay upfront, an earn-out can close that gap—effectively saying, “We’ll pay more if it performs.”
• Key management (often the sellers themselves) are staying on post-sale. Earn-outs are frequently used to incentivise continued involvement and ensure alignment between the seller and buyer. They encourage a smooth transition and continued effort during the handover period, benefiting both parties.
• There’s a strategic component to the deal. In cases where the buyer sees longer-term value (e.g., market entry, cross-sell opportunities, tech integration), an earn-out can delay payment until that value starts to materialise, giving time for the buyer’s strategic assumptions to play out.

Common Earn-Out Metrics

Earn-outs can be based on a variety of financial and operational metrics, and choosing the right one is crucial to creating a structure that is fair, motivating, and easy to monitor.

• Revenue: Revenue-based earn-outs are straightforward and easy to measure, making them attractive when simplicity is key. However, they do not account for profitability, so a business could hit revenue targets while making little or no profit. This method may be suitable for businesses with high top-line growth, particularly in sectors like SaaS, e-commerce, or early-stage product launches.
• EBITDA or Net Profit: These are common and typically preferred by buyers because they are linked directly to the business’s ability to generate cash or profit. EBITDA removes distortions caused by financing or non-cash items, while net profit includes all expenses and is closer to the bottom line. The downside is that these figures can be influenced by discretionary spending or changes made by the buyer after completion. Therefore, sellers should ensure that definitions are tightly agreed and protections are in place.
• Gross Profit: Gross profit earn-outs focus on revenue minus direct costs, excluding overheads. This metric is often more stable than net profit and less open to manipulation than EBITDA. It’s particularly effective in businesses with high or variable operating costs where earnings can be influenced by external factors like market pricing, delivery costs, or headcount growth.
• Non-financial KPIs: Occasionally, deals use operational milestones as earn-out triggers—examples include securing a major customer contract, hitting product development milestones, or completing a technology integration. These are most common in strategic or venture-driven acquisitions. However, they can be subjective or difficult to verify, so require careful definition and objective measurement criteria.

The choice of metric depends on the business’s characteristics, sector dynamics, and what both parties believe will fairly reflect performance. At Dexterity Partners, we help sellers model and stress-test various earn-out metrics to determine which ones create the clearest link between value creation and payout, while minimising the risk of disputes.

Structuring the Earn-Out

A well-structured earn-out needs to be clearly defined, commercially balanced, and legally robust to avoid confusion and disputes down the line. The clarity and precision with which these terms are documented can significantly influence the seller’s ability to realise the full earn-out potential. Key considerations include:

• Measurement Period: Typically set for a period of 12–36 months following completion. Sellers generally benefit from shorter earn-out periods, as they reduce the duration of financial exposure and limit the window in which external market forces or buyer-led changes can impact results. Buyers, on the other hand, may prefer longer periods to ensure sustained performance rather than short-term uplifts.
• Caps and Floors: Including a cap (maximum earn-out) protects the buyer from overpaying if performance exceeds expectations significantly, while a floor (minimum earn-out) can offer the seller reassurance that some value will be received if performance meets a basic threshold. A tiered structure, with increasing payouts at set milestones, can also be used to motivate over-performance.
• Payment Timing: Earn-outs are generally paid annually in arrears, but in certain high-cash-flow situations, quarterly payments may be agreed. Sellers should ensure there is a clear timeline for calculating, verifying, and remitting each instalment—and include provisions for interest on late payments if delays occur.
• Governance and Oversight: Sellers must negotiate protections that prevent the buyer from making changes that could adversely affect the ability to achieve earn-out targets. This may include restrictions on cost-cutting, staff changes, redirection of sales resources, or limiting capital investment. Sellers may also negotiate ongoing access to key financial information or reporting to monitor progress during the earn-out period.
• Accounting Standards: A common source of earn-out disputes is the interpretation of EBITDA or other performance metrics. The agreement should clearly specify how each metric will be calculated, using agreed accounting standards, and identify any specific inclusions or exclusions. For example, the treatment of exceptional items, management bonuses, or intercompany charges should be agreed in advance.

In addition to these elements, it’s also wise to outline dispute resolution mechanisms, define material changes in business operations, and determine how the business will be run during the earn-out to ensure alignment between buyer and seller throughout the term.

Risks and Challenges for Sellers

While earn-outs can increase the total consideration, they come with risks that need to be managed carefully:

• Loss of Control: Once the buyer assumes operational control of the business, they have the ability to change how the company is run. This can include restructuring teams, cutting costs, diverting resources, or altering strategy—all of which can negatively affect the business’s ability to meet the agreed earn-out targets. Sellers should consider requesting protective clauses to limit the buyer’s ability to make material operational changes during the earn-out period.
• Cultural Clashes: Sellers who remain involved post-sale may find themselves working within a very different company culture, especially if the buyer is a larger corporate or private equity firm. Differences in decision-making, pace, and values can lead to misalignment, frustration, or disengagement, all of which can influence the seller’s ability to deliver on performance targets.
• Accounting Disputes: One of the most contentious areas of earn-outs is how the performance metrics—particularly EBITDA or profit—are calculated. Buyers may interpret or adjust figures in a way that reduces or eliminates earn-out payments. This could include reclassifying costs, allocating shared overheads differently, or increasing discretionary spending. Sellers must push for precise definitions and agreed accounting treatment within the legal agreement.
• Delays in Payment: Even where earn-out targets are met, payments can be delayed due to internal disputes, cash flow prioritisation, or disagreements over calculations. Without clear terms on timelines and enforcement mechanisms, sellers may be forced into legal action to recover agreed sums.
• Psychological Toll: Earn-outs can create prolonged uncertainty for sellers, particularly when a significant portion of the sale value is at stake. This extended exposure to risk—and the requirement to continue actively managing the business—can lead to stress and strain, especially when there is tension with the buyer.

To mitigate these risks, earn-outs must be carefully drafted, negotiated with a full understanding of operational realities, and supported by strong legal and advisory teams who can anticipate and protect against common pitfalls.

Advantages of Earn-Outs

For sellers, earn-outs can be an effective way to:

• Maximise value when the business has strong growth potential. If the business is poised for future expansion—perhaps due to product roll-outs, contracts in negotiation, or market tailwinds—an earn-out can allow sellers to share in that upside, achieving a higher overall exit value than might otherwise be agreed upfront.
• Demonstrate confidence in the business’s future. Agreeing to an earn-out signals to buyers that the seller truly believes in the company’s ongoing performance and is willing to have some “skin in the game”—which can increase buyer confidence and improve deal terms.
• Align interests with the buyer and support a smoother transition. By linking part of the value to post-sale results, both parties have an incentive to work collaboratively during the transition period, easing integration and helping to retain key staff or customers.

For buyers, earn-outs:

• Reduce upfront risk. Particularly helpful when a business is experiencing growth or uncertainty, an earn-out allows the buyer to tie part of the purchase price to actual performance, lowering the risk of overpaying.
• Encourage ongoing seller involvement and performance. If the seller stays on post-sale, an earn-out helps motivate continued leadership, ensuring that knowledge is retained and operational momentum is sustained.
• Ensure part of the consideration is directly linked to actual results. This performance-based structure protects the buyer’s investment and provides a built-in mechanism for value validation before all funds are paid.

When to Avoid Earn-Outs

Earn-outs aren’t suitable for every situation. They may not be appropriate when:

• The seller is not staying on post-completion. If the seller will not be involved in the business after the sale, they have little to no control over performance and thus limited ability to influence whether the earn-out is achieved. In such cases, relying on an earn-out introduces excessive risk.
• The business’s future performance is too unpredictable. For businesses in emerging markets, with unproven models, or high external dependencies, projecting future performance accurately is challenging. Earn-outs in these scenarios often lead to disputes because targets are missed due to factors outside the seller’s control.
• There is little alignment between buyer and seller. If the buyer has a very different strategic vision or operational approach, it may lead to conflicting priorities that undermine performance targets. Earn-outs rely on cooperation and shared goals—where this doesn’t exist, they are more likely to fail.
• There is a lack of trust or transparency. If the parties don’t have a strong working relationship or the buyer is unwilling to provide ongoing financial visibility, the seller may be at a disadvantage when it comes to verifying results and calculating earn-out payments. In these cases, a higher upfront payment with fewer contingencies is usually preferable.
• The administrative burden outweighs the benefit. For smaller deals, the complexity and cost of administering an earn-out—tracking performance, legal oversight, and potential arbitration—may outweigh the incremental value it provides. In such cases, a cleaner structure with a simplified deal mechanism can be more efficient for all parties.

What Dexterity Partners Recommends

At Dexterity Partners, we always seek to maximise upfront consideration for our clients wherever possible—minimising reliance on future contingencies and maximising certainty. However, in cases where an earn-out is the right tool to achieve the best overall outcome, we take a proactive and rigorous approach to ensure it is structured fairly and effectively.

We begin by conducting detailed valuation modelling to assess what the earn-out might realistically deliver, stress-testing different scenarios so our clients understand the upside, downside, and likelihood of each outcome. We don’t just accept the buyer’s proposal—we challenge assumptions, model alternative structures, and ensure the earn-out complements the wider deal.

We then support our clients in negotiating terms that are robust, enforceable, and commercially balanced. This includes:

• Choosing the right performance metrics that can be measured transparently and are not easily manipulated.
• Defining realistic and achievable targets based on past performance and agreed growth assumptions.
• Building in clear protections around control, governance, and operational support, so the business isn’t set up to fail.
• Ensuring reporting obligations, dispute resolution processes, and payment timelines are all clearly documented.

Most importantly, we make sure the earn-out is just one part of a carefully considered strategy that aligns with our clients’ wider personal, financial, and professional goals—whether they are exiting completely or continuing in a leadership role post-sale.

Final Thoughts on Business Earn-outs

Earn-outs can be a powerful tool in business sales, but they are not without complexity and risk. A well-structured earn-out can enhance value and enable a deal to be done where otherwise expectations may be too far apart. But careful planning, clear definitions, and trusted advisers are essential.

If you’re considering selling your business and want to explore whether an earn-out could play a part, speak to Dexterity Partners. We’ll help you structure the deal that’s right for you—not just in theory, but in real financial outcomes.