Glossary · UK
What is Earn-Out Clause?
A business sale term where part of the price is paid later and depends on the business hitting agreed performance targets after completion.
Full Definition
An earn-out clause is a provision in a business sale agreement under which part of the purchase price is deferred and made conditional on the business achieving specified performance targets -- such as revenue, profit or customer retention thresholds -- over an agreed period after completion, typically one to three years. Earn-outs are often used to bridge a valuation gap between what a seller believes the business is worth (based on optimistic future growth) and what a buyer is willing to pay upfront given the uncertainty of that growth actually materialising, effectively sharing the risk between the two parties: the seller receives a lower guaranteed price at completion but has the opportunity to receive further consideration if the business performs as forecast. Earn-out arrangements can create tension after completion, since the seller (often still working in the business during the earn-out period) may want to run it in a way that maximises the earn-out metric, while the new owner wants to integrate the business into wider group strategy, make investment decisions for the longer term, or change reporting practices -- disputes over how the business was run, or how the earn-out metric was calculated, during the earn-out period are a common source of post-completion litigation. Because of this, well-drafted earn-out clauses usually specify in detail how the business must be operated during the earn-out period, how the target metric is calculated and audited, and what happens if the buyer sells the business or changes its strategy before the earn-out period ends.