Earnouts: bridging buyer-seller expectations

Earnouts are a common completion mechanism in M&A deals. We examine how they work for buyers and sellers.

Alongside locked box and completion accounts mechanisms, earnouts are also widely used in M&A transactions as a post-completion price adjustment mechanism, altering the total consideration of a deal to reflect value fluctuation post the transaction.

Earnout agreements typically specify an earnout period, during which the operating performance of the business is measured to determine the payment of the contingent or variable portion of the purchase price, as illustrated in the timetable below.

Earnout calculations are most commonly based on one or more of the following criteria:

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Sales-based criteria

Revenue/turnover

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Profit-based criteria

EBITDA/EBIT

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Other non-financial criteria

Specific milestone (e.g. entering a new market or launch of a new product)

The earnout period is generally set at 1-3 years, with the calculation method varying depending on the criteria used and the commercial negotiation between the parties to the transaction.

By way of illustration:

Where milestone-based metrics apply, earnout payments are typically structured as fixed amounts payable upon achievement of defined milestones.

For example, EUR 5 million upon entering a new market or launch of a new product, with an additional EUR 2 million if cumulative sales exceed EUR 50 million within the earnout period.
Where financial metrics are used, earnout payments are more commonly structured on a capped, target-based approach, under which specified payments become payable if agreed revenue or EBITDA targets are achieved during the earnout period, often on a tiered basis:
For example, an earnout may be structured as below:
1. No earnout payment if revenue is below EUR 50 million;
2. EUR 5 million plus 10% of the excess amount if revenue is between EUR 50 million and EUR 60 million;
3. EUR 8 million plus 15% of the excess amount if revenue exceeds EUR 60 million, subject to an overall cap of EUR 14 million.
Multiple-based structures may also be used (e.g. 1x, 3x or 5x revenue or EBITDA achieved), although these are generally less common due to their greater complexity and the increased potential for disputes in relation to the earnout calculation.

Purpose of earnouts:

gambling or hedging?

The rationale for adopting an earnout mechanism differs from the perspectives of buyers and sellers.

From a buyer’s perspective, earnouts serve as a tool to transfer part of the business risk back to the seller and mitigate the risk of overpayment. By linking a portion of the purchase price to post-completion performance, buyers can better align consideration with actual value realization. At the same time, earnouts may also provide buyers with financing flexibility, as deferred payments reduce upfront cash requirements.

In addition, earnouts are particularly common in founder-led transactions or businesses that are heavily dependent on the sellers’ continued involvement, such as where customer relationships, know-how or business development are closely tied to key individuals. In these situations, buyers often use earnout arrangements to manage key-person risk and support a stable transition by incentivizing sellers to remain involved post-closing. This may include linking earnout entitlement to continued employment, service obligations or the achievement of operational or commercial milestones during a defined post-completion period.

From a seller’s perspective, earnouts can be attractive where there is confidence in the future growth of the target business. Under an earnout structure, sellers retain exposure to upside potential without the need for further capital investment, effectively monetizing future performance.

Market practice and deal preferences

Based on a synthesis of publicly available studies, market data published by various institutions, and our experience across a substantial number of transactions, earnout mechanisms have been used in approximately 20%-30% of M&A transactions in Europe and the United States in recent years, with overall usage remaining relatively stable.

Earnouts tend to be significantly more prevalent in technology, life sciences and other high-growth sectors – even exceeding 70%. This reflects the fact that valuations here are heavily dependent on future developments, including projected sales growth or the achievement of regulatory, technical or commercial milestones (e.g. obtainment of specific regulatory or commercial authorization/licenses).

Earnouts are also more commonly used in private target acquisitions and smaller deals than in public target or larger transactions. Public targets and larger transactions typically involve more mature and predictable business models, reducing the need for contingent pricing mechanisms.

Key concerns

Earnouts are typically considered where, in the course of valuation and pricing discussions based on the seller’s business plan, the buyer identifies material uncertainties in respect of the seller’s forward-looking projections or where there are significant divergences between the parties regarding key underlying assumptions. In such circumstances, earnouts are often introduced as a mechanism to bridge valuation gaps and allocate future performance risk between the parties. Against this backdrop, identifying such uncertainties and designing appropriate safeguards through the structuring of earnout terms becomes a central focus during the negotiation phase, requiring informed commercial judgment supported by a detailed understanding of the target business and its key value drivers.

Financial uncertainties
Non-financial uncertainties
Sale and Purchase Agreement (SPA) stage

Financial uncertainties often relate to revenue sustainability or future cash flow generation. For example, where turnover is highly dependent on a limited number of customer relationships, buyers may use earnouts to secure a smoother handover. Similarly, where value or return is closely linked to profitability over the next one to three years, earnouts can help ensure a more equitable allocation of transaction consideration.

Non-financial uncertainties vary across industries and business models. Common examples are entering a new market or launching a new product, which may constitute a fundamental and critical assumption for the valuation conducted in the transaction.

Irrespective of the nature of the uncertainty, these issues should be clearly identified and addressed as early as possible in negotiations.

At the Sale and Purchase Agreement (SPA) stage, the focus shifts to translating commercial intent into precise contractual mechanisms. This typically requires close collaboration between legal and financial advisers, particularly in designing and documenting detailed provisions covering earnout calculations, reporting and monitoring obligations, applicable accounting standards and agreed assumptions or restrictions.

Following signing, ongoing reporting, review and communication become critical. Fair and accurate disclosure in accordance with agreed standards directly affects the final earnout outcome. Robust documentation and record-keeping are essential, especially in the event of disputes regarding earnout calculations.

What matters next –

ensuring fairness, managing financial risk and optimizing tax outcomes

From a financial perspective, apart from the earnout review which requires deep financial involvement to ensure accuracy and fairness, financial statement impact and tax planning are also essential topics.

In practice, similarly to a completion accounts review, an earnout review often requires familiarity with both the transaction background and deep transaction expertise supported by extensive experience. Therefore, continuity of advisory teams across financial due diligence, transaction support and earnout review can significantly reduce time and costs.

For many deal parties, particularly public companies with their responsibilities to shareholders, the earnouts-related accounting treatment and disclosures will be important aspects, including the initial measurement of investment cost, recognition of goodwill and subsequent impacts on profit or loss arising from remeasurement of contingent consideration. As these aspects will have impacts on the consolidated financials post the transaction, early planning with appropriate financial experts is therefore critical for both buyers and sellers.

Meanwhile, earnouts also carry tax implications, especially for the Seller. The estimation and final settlement of earnout payments may affect capital gains tax, withholding tax, corporate income tax and other tax exposures. Early involvement of tax specialists can help ensure compliance across relevant jurisdictions while maximizing available tax efficiencies.

As a global firm of financial and tax specialists operating across Europe and beyond, we have extensive experience supporting transactions involving earnouts, locked box, completion accounts and other tailored pricing mechanisms. Combined with our in-depth understanding of regional trading practices in Europe, the United States and other markets, we help clients prepare more thoroughly for transactions and navigate complex deal-related issues with greater confidence and control.

We would be pleased to discuss your specific transaction plans and explore how we can support you.