The earn-out: bridging the gap between buyer and seller

What is an earn-out?

With an earn-out, part of the purchase price is linked to achieving predefined targets within a specified period following the acquisition.

The parties can tailor these criteria entirely to the transaction. Depending on the circumstances, the targets may be financial, such as achieving a certain level of revenue, EBITDA and/or profit, but also operational, such as retaining key customers or employees or launching a new product.

Please note: From a tax perspective, it is important to formulate the chosen criteria carefully. If the earn-out is too closely linked to the seller’s future (management) performance, there is a risk that the additional consideration will be reclassified as professional income rather than as part of the purchase price.

Attractive for both buyer and seller

• A seller may ultimately obtain a higher purchase price and share in the company’s future growth, which builds on their previous efforts and investments.

• For the buyer, an earn-out reduces the initial cash outflow at closing and limits the risk of overvaluing the shares. In addition, the seller generally remains involved in ensuring a smooth transfer of the business, which supports continuity. An earn-out may also discourage the seller from immediately developing competing activities after the transaction.

However, there are several points to consider:

• For the seller, part of the purchase price remains uncertain. Following the acquisition, the seller has only limited influence over the management of the company, even though management decisions may directly affect whether the earn-out targets are achieved.
• For the buyer, an earn-out means less freedom to manage the company entirely as they see fit during the earn-out period, as well as additional administrative and legal follow-up after the acquisition.

What should you consider?

A well-drafted earn-out arrangement helps prevent disputes later on. It is therefore essential to agree clear terms in advance regarding, among other things:

• the specific and measurable targets to be achieved (e.g. EBITDA of at least EUR X over the next two years);
• the conduct rules that the company and the buyer, as its new owner, must observe during the earn-out period (e.g. not incurring exceptional costs or changing activities in ways that could affect the earn-out);
• the seller’s information and audit rights;
• the duration of the earn-out arrangement following closing;
• the settlement dates and payment terms (e.g. an all-or-nothing payment or proportionate consideration based on the targets achieved);
• the procedure for resolving any disputes (e.g. involving an independent accountant or mediator).

An earn-out can bridge differences of opinion and increase the chances of a successful transaction, but the devil is in the detail. Clear contractual arrangements and thoughtful structuring make the difference between a successful compromise and a new source of conflict.

Our PKF BOFIDI Legal experts are here to help

PKF BOFIDI Legal assists both buyers and sellers with business transfers and, in particular, with drafting legally robust earn-out arrangements, enabling both parties to reach an agreement with confidence.

Do you have questions about an earn-out or are you preparing for a business transfer? Feel free to contact our specialists. We will be happy to explore the options with you.

This article was written by Jasper Caby and Silke Uyttendaele