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Corporate Finance Faculty Best-Practice Guideline 70

Earn-outs in deals

Earn-out agreements are often used to close deals when the seller of a business remains involved, but getting them right is far from straightforward. This best-practice guideline considers how to agree, document and account for earn-outs.
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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.

Photos by Matt Fowler Photography
Earn-out agreements
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