Earn outs: how they work and how to protect yourself

An earn out is the part of the price the buyer does not pay you at signing, but later, on condition that the business hits certain results after the sale. In theory it is a bridge: the seller believes the business is worth more, the buyer will not pay for that upfront, so the two sides share the risk on future performance. In practice it is often the worst negotiated clause in SME and startup sales, because the seller signs looking at the headline price rather than the share they have a real chance of collecting. The base rule is easy to state and hard to accept: never sign a deal you would not be happy with if the earn out paid out zero.

What an earn out is really for

An earn out answers a disagreement about value. You think the business will keep growing, the buyer is not sure and refuses to pay today for performance they do not yet control. Rather than break the deal, both sides agree on extra price paid if certain targets are met over a period of one to three years. It is also a retention tool: the buyer keeps the owner motivated and present through the transition, which matters when the business still leans heavily on its founder. The tool itself is defensible. What is far harder to defend is loading the entire risk onto the one party that no longer holds the wheel. You.

The six parameters that decide everything

An earn out comes down to six decisions. Each one can win or lose you a real share of the price. Before you discuss the amount, demand clarity on these six points, in writing.

• The reference metric: what is the earn out calculated on? Revenue, gross margin, EBITDA, net income? The further down the income statement you go, the more the buyer can influence the figure through their own decisions.
• The threshold and the curve: at what level does the earn out trigger, and how does it scale? All or nothing at a single threshold, or linear between a floor and a ceiling?
• The cap and the floor: is there a maximum payable, and a minimum guaranteed if you come close to the target without reaching it?
• The period: one, two or three years? The longer it runs, the more exposed you are to decisions you no longer make.
• The payment schedule: yearly or at the end? Cumulative or independent year by year? A bad year can wipe out a good one if the periods offset each other.
• The conduct rules during the period: what the buyer can and cannot do, so they do not run the business against your earn out.

A worked example that shows the trap

Take a business sold for 5 million euros, with 3 million paid at signing and a 2 million earn out over two years, conditional on cumulative EBITDA. Current EBITDA is 800,000 euros a year. The target is set at 900,000 euros a year, meaning 12.5% growth expected each year after you leave. On paper the deal is worth 5 million. But look at what happens if, just after signing, the buyer charges 150,000 euros a year of head office costs to your business, freezes your sales hires to protect their own cash, and moves two of your best salespeople to another part of the group. EBITDA drops to 700,000 euros, the target is never met, and your earn out is worth zero. You sold for 3 million, not 5, and the drop in performance was not your doing. Nothing here is exotic: every lever pulled in this scenario is perfectly legal. I have watched this play out almost frame by frame for a seller who came to us too late.

An earn out indexed to a metric the buyer can manipulate is not additional price. It is a free option written at your expense.

Choosing the right metric

The choice of reference metric is the single most important decision, because it sets how far the buyer can influence your payout. Revenue is the hardest to manipulate, but it ignores profitability: the buyer can chase unprofitable volume to trigger your earn out, which does not protect you either. EBITDA reflects operating performance better, but it is sensitive to accounting choices, intragroup recharges, cost allocations and investment. Net income is the worst for the seller: it depends on the financial structure, the acquisition debt and the tax, all decided by the buyer.

• If the metric is EBITDA, demand a written, line by line definition of which costs are in and out, and forbid in writing any new or increased head office charges, management fees or group costs.
• Prefer gross margin or a tightly defined EBITDA over net income, which depends on financial decisions you no longer control.
• If revenue is the metric, add a minimum margin condition to rule out unprofitable growth.
• Fix the accounting principles to those used to set the target, so the rules are not changed midstream.

The protective clauses you must never skip

Forget the handshake. Anything that is not written into the contract does not exist, and I have watched sellers learn that two years too late, when the basis of calculation had been quietly redefined without them. Four families of protection matter above all.

• Conduct covenants: the buyer commits to run the business in the ordinary course, to keep the marketing budget and the sales headcount, not to move customers or activity to other entities, and not to change pricing policy in a way that harms you.
• Your role and your means: if you stay as manager during the earn out, your powers must be written down. A manager stripped of all decisions cannot be held responsible for a missed target.
• Acceleration: if the buyer dismisses you without serious cause, resells the business, or radically changes its scope during the period, the earn out becomes immediately and fully due.
• Transparency and arbitration: a right of access to the accounts used for the calculation, regular reporting, and an independent expert mechanism for disputes over the figure, rather than long litigation.

Sizing the earn out

Beyond the mechanics, the real question is how much of the price you agree to put at risk. An earn out worth 15 to 25% of total price is generally bearable, because a disappointment stays contained. Above 40%, you are no longer selling your business: you are still working for it, under someone else’s authority, betting on results you only partly control. The bigger the earn out, the more every protective clause counts, and the more the financial strength of the buyer has to be checked: additional price promised by a fragile buyer, or by a vehicle with no assets, is worth only as much as its ability to pay in three years.

Many of these difficulties disappear when the business no longer depends on its owner and shows clean, defensible numbers: a buyer who sees readable, transferable performance is more willing to pay upfront, and so to shrink the earn out. That is exactly the preparation work we set out in our guide to preparing your company for sale, and that our readiness assessment lets you measure point by point. Before you even negotiate the clause, know where your business stands: that is what gives you the power to turn an earn out imposed on you into price you actually collect.

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