Earn-outs come up in almost every business sale conversation at some point. The idea is appealing in theory: the buyer pays a base price now, with additional payments tied to future performance. The seller gets rewarded if the business keeps growing. The buyer gets protection if it does not. Everyone shares the risk.
In practice, earn-outs create more problems than they solve for most sellers. This article explains why, when they might genuinely make sense, and what structures actually work better for both sides.
What is an earn-out?
An earn-out is a deferred payment mechanism where part of the purchase price is contingent on the business achieving agreed performance targets after settlement. The seller receives the base price at settlement and earns additional payments — typically over one to three years — if the business hits the agreed metrics.
Earn-outs are most commonly proposed when there is a gap between what the buyer is willing to pay based on current performance and what the seller believes the business is worth based on future potential. The earn-out is the mechanism that bridges that gap — in theory.
Why earn-outs rarely work for sellers
The fundamental problem with an earn-out is that the seller no longer controls the business. Once settlement occurs, the buyer makes the decisions. Staffing, pricing, marketing spend, supplier relationships, capital investment — all of it is now in the buyer's hands. The seller's earn-out payment depends entirely on outcomes they cannot influence.
This creates an obvious tension. A buyer who wants to reduce costs, restructure the business, or integrate it into a larger operation may make decisions that are entirely rational from their perspective but that reduce the earn-out payment to the seller. There is no bad faith required — the buyer is simply running the business the way they see fit. The seller watches their earn-out erode and has limited recourse.
There are also practical issues with measurement. Net profit is the most common earn-out metric, but it is also the most easily manipulated. A buyer can increase management fees, accelerate depreciation, allocate shared costs to the acquired business, or simply defer revenue recognition. None of this needs to be fraudulent — it can all be legitimate accounting — but the effect is to reduce the profit figure on which the earn-out is calculated.
For sellers who are stepping back from the business — particularly those selling to retire or reduce their workload — an earn-out means staying financially exposed to a business they no longer run, for one to three years, with limited ability to influence the outcome. That is not a retirement. It is an extended period of anxiety.
When an earn-out might make sense
There are situations where an earn-out can work, but they require a specific set of circumstances.
The seller needs to be staying in the business in a meaningful capacity — not just a transition role, but an ongoing operational or management role where they can actually influence the performance metrics. If the seller is going to be running the business for the next two years anyway, an earn-out aligns their interests with the buyer's and gives them a genuine opportunity to earn the additional payment.
Younger sellers who are not looking to exit completely, or sellers who are genuinely excited about the business's growth trajectory and want to participate in it, are better candidates for earn-out structures than sellers who are ready to move on.
Even in these cases, the earn-out metric matters enormously. Net profit is almost always the wrong metric. Gross profit is more defensible — it is harder to manipulate through cost allocation — but still vulnerable to revenue recognition decisions. Gross revenue is the most transparent metric: either the revenue came in or it did not. For businesses where revenue is the primary driver of value, a gross revenue earn-out is the most seller-friendly structure.
Better alternatives for most sellers
In most transactions, there are structures that achieve the same economic outcome as an earn-out — bridging the gap between buyer and seller on price — without putting all the risk on the seller.
Unconditional deferred payments
The most straightforward alternative is a structured payment arrangement where the purchase price is split into two or three tranches, paid at agreed intervals after settlement, with no performance conditions attached. The buyer gets time to pay — which addresses their cash flow concern — but the obligation is unconditional. The seller knows exactly what they will receive and when.
This is sometimes called vendor finance, though it is more accurately described as a deferred payment obligation. The risk sits entirely with the buyer: if the business underperforms, they still owe the money. This is a fundamentally different risk profile to an earn-out, where underperformance reduces what the seller receives.
A second or third payment structure — for example, 70% at settlement, 20% at twelve months, 10% at twenty-four months — gives the buyer breathing room while giving the seller certainty. It is simpler to document, simpler to administer, and far less likely to end in a dispute.
Retention adjustments for service businesses
For service businesses where client retention is the primary risk — accounting practices, bookkeeping firms, financial planning businesses, and similar recurring-revenue operations — a retention adjustment can be a fairer and more targeted mechanism than an earn-out.
The structure works like this: the purchase price is agreed based on the current client base. If clients leave in the period immediately after settlement — typically three to six months — an equivalent adjustment is made to the purchase price. Once a client has transitioned and stayed, the adjustment period ends and the buyer takes on full responsibility for retention from that point.
This is not an earn-out. It does not reward the seller for growth. It simply protects the buyer against the specific risk that clients leave at the point of sale — which is a legitimate concern in a relationship-based business — without exposing the seller to the buyer's management decisions over an extended period.
The retention adjustment period should be short. Three to six months is usually sufficient to determine whether clients are going to stay. Once a client has received their first invoice from the new owner, attended their first meeting, or had their first interaction with the new team, the transition risk has largely passed. Extending the adjustment period beyond six months starts to look like an earn-out by another name.
Importantly, once the adjustment period ends, it is the buyer's responsibility to keep those clients. The seller's obligation is to facilitate a proper handover — introductions, documentation, transition support. What happens after that is on the buyer.
Choosing the right structure
The right payment structure depends on the seller's situation, the nature of the business, and what is actually driving the gap between buyer and seller on price.
If the gap is about future growth potential that the seller believes in and the buyer is sceptical of, and the seller is staying in the business, an earn-out on gross revenue might be appropriate. If the gap is about the buyer's ability to fund the full price at settlement, a deferred payment structure is almost always cleaner. If the gap is about client retention risk in a service business, a short retention adjustment is more targeted and more equitable than either.
What does not work is an earn-out imposed on a seller who is ready to exit, measured on net profit, over a two-year period, in a business the buyer is going to restructure. That structure benefits the buyer almost entirely and should be resisted.
Next steps
If you are negotiating the sale of a business in NSW and want advice on payment structures — including whether an earn-out, deferred payment, or retention adjustment is appropriate for your situation — contact Richard Matthews at Link Business NSW for a confidential discussion.
