Earn-out in business sales: General information

In our last posts, we have demonstrated how corporate value can be determined and how the selling price develops from this. However, if the buyer and seller do not agree on the selling price or have different views regarding the future of the company, an earn-out can be of help.

As we explained in the article series «Methods of Business Valuation», the value of a company can be determined in several ways and varies depending on the method chosen. However, the selling price of the company usually does not correspond to the corporate value, as subjective factors still influence the negotiation, which have a tremendous impact on price negotiations. If the expectations of the seller and buyer differ too much in such cases or if there are different views regarding the further future of the company, an earn-out can be the solution.

What is an Earn-out?

In an earn-out, the selling price is split into two parts: on one hand, a fixed, immediate cash payment (also known as «Upfront Payment») is due, and on the other hand, a performance-based additional payment at a later date («Earn-out») is owed. The amount of the earn-out depends on how successful the company is during the contractually defined time window. Especially when sellers and buyers have different views on company value, future market growth or future realizable profits, a so-called earn-out clause can provide the solution. It also helps to better balance financial risks, which are largely borne by the buyer during the company purchase. Earn-outs are therefore often used in the sale of startups or in times of economic stagnation. Another case example for the earn-out is the continued employment of the CEO after the sale. Because the amount of the earn-out payment depends on the success of the company, it gives him an incentive to manage the company as profitably as possible.

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