Earn-outs are increasingly common in M&A transactions and can help facilitate deals. They are not used in all transactions, but are particularly prevalent during periods of economic uncertainty.
Earn-outs influence value by impacting the final price paid and received for a business. As earn-outs are based on future business performance following a change of ownership, they can be complex to agree, both commercially and contractually.
This Corporate Finance Faculty best-practice guideline, authored by Grant Thornton, explores the factors that can influence the outcome of an earn-out agreement, for both the buyer and the seller, and illustrates its benefits and the potential pitfalls.
Earn-outs are particularly useful where:
- the purchaser is acquiring a business in a market or industry where future performance is less predictable;
- the target business is expected to experience significant growth in the near future and the seller wishes this to be factored into the price;
- it is beneficial to retain the expertise and to encourage existing management to ensure the future success of the business; or
- there is a perception gap between the parties in the valuation of the business resulting from different expectations of future performance.
In these circumstances, an earn-out can reduce the purchaser’s risk of overpaying based on growth assumptions that do not transpire, while providing the seller with the opportunity to benefit from a strong post-transaction performance.
This guideline explains:
- how an earn-out agreement can help to successfully complete a deal;
- the financial, tax and accounting considerations of an earn-out agreement;
- how to reflect an earn-out in the SPA;
- how to avoid and resolve disputes; and
- how to prepare earn-out accounts to calculate the earn-out amount.
A carefully agreed earn-out mechanism can result in a meeting of minds between principals and facilitate a transaction that would otherwise not be successful. A well-structured earn-out can also help drive behaviours that boost the performance of a business post-transaction.
Further reading
Corporate Finance
Tax topics
Photo gallery
Photos from the launch of the Earn-out Agreements guideline, which took place on 18 October 2023 at ICAEW Chartered Accountants' Hall.
