Definition
An earn-out is part of the purchase price that is paid only if the business meets agreed targets over a set period after the sale, such as revenue, gross profit or EBITDA. It bridges a gap between what the seller believes the business is worth and what the buyer is willing to pay on the current evidence. The seller often stays involved in the business while the earn-out runs.
EBITDA is earnings before interest, tax, depreciation and amortisation. It helps compare operating profit across businesses, but it is not the same as cash.
Worked example
Saltmarsh Digital Ltd is a fictional UK marketing agency. The seller wants £2,000,000; the buyer will pay £1,500,000 on current earnings. They agree:
- £1,500,000 paid at completion
- up to £500,000 more over two years, paid in proportion to how close gross profit comes to agreed targets
Gross profit reaches 80% of the targets, so the seller receives £400,000 of the earn-out and the total price is £1,900,000.
Why buyers care
An earn-out shares risk: you pay the full price only if the results the seller promised actually arrive. It can also keep a seller engaged through the handover.
It needs careful drafting. Targets must be measurable and defined in the purchase agreement, including which accounting policies apply and what happens if you change pricing, merge the business with another or cut costs. Sellers may argue that your decisions reduced their payout, and vague terms invite disputes.
A seller who refuses any earn-out or seller finance, on a price that rests on forecasts, is worth questioning. Take legal and tax advice in your country on how an earn-out should be structured.
Seller finance is when the seller lends the buyer part of the purchase price, to be repaid with interest after completion. It is also called vendor finance or a seller note.