An earn-out allows the purchase price of a business to be varied according to the financial performance of the business after the sale, and often, to be paid from future cashflows of the business being sold.
The provision is typically used if the buyer cannot obtain financing for the purchase price in full, and/or the buyer and the seller want to use the future performance of the business to agree the purchase price.
What is an ‘earn-out’ exactly?
An ‘earn-out’ is a provision in the sale agreement for the business which adjusts the overall purchase price by referring to a financial measure for the business after the sale.
The purchase price will typically be divided into an initial agreed lump sum amount, followed by one or more further earn-out amounts which are calculated by reference to the profit of the business over one or more agreed periods after completion of the business sale.
The further earn-out amounts could also be linked to measures other than profit, such as revenue, new clients or number of products sold during the earn-out period.
What are the advantages of using an earn-out?
An earn-out might be advantageous to both the buyer and the seller:
What are the disadvantages of using an earn-out?
An earn-out has potential disadvantages, for example: