In today’s business sale landscape, it’s increasingly rare for sellers to walk away with the full sale price paid up front. Instead, many deals now feature an earn-out, a structure where part of the consideration is paid later, and is conditional on the business meeting specific performance targets post-sale.

Earn-outs can be the bridge that closes valuation gaps and keeps negotiations alive, but they also introduce risk, complexity, and a range of tax implications that every entrepreneur should understand before signing on the dotted line. Here’s what you need to know, with practical advice inspired by The Exit Roadmap by Chris Spratling.

1. What Is an Earn-Out?

An earn-out is a mechanism where part of the sale price is contingent on the business hitting certain financial or operational targets—usually over one to three years after the deal completes.

– Typical triggers: EBITDA, revenue, gross profit, or retention of key clients/staff.

– Purpose: Aligns the interests of buyer and seller, especially when there’s disagreement on the company’s future performance.

2. The Rewards: Why Consider an Earn-Out?

– Bridges valuation gaps: If buyer and seller can’t agree on a price, an earn-out lets both parties “share” future risk and reward.

– Maximises total sale price: If you’re confident in your business’s prospects, an earn-out can boost your total proceeds above the initial payment.

– Smooths transition: Earn-outs often require sellers to stay involved, helping ensure business continuity.

3. The Risks: What to Watch Out For

– Loss of control: After the sale, the buyer calls the shots. Changes in strategy, investment, or staffing can impact your ability to hit targets.

– Disputes and ambiguity: Vague or poorly defined metrics, or lack of clarity on how targets are measured, are a recipe for conflict.

– Payment delays or non-payment: If targets aren’t met—whether due to market conditions or buyer actions—you may receive less (or nothing) of the earn-out.

Tips to reduce risk:

– Insist on clear, objective metrics and robust reporting.

– Negotiate protections (e.g., “no material adverse change” clauses or consultation rights).

– Set out dispute resolution mechanisms up front.

4. Tax Implications: What You Need to Know

The tax treatment of earn-outs is complex and depends on the deal structure:

– Capital Gains Tax (CGT): In most cases, HMRC requires you to estimate the total likely earn-out value at completion, taxing it in the year of sale—even if you don’t receive the full amount for several years.

– If the actual earn-out differs: You may need to reclaim overpaid tax or pay more if you exceed your estimate, creating admin headaches and cash flow challenges.

– Payments in shares/securities: If earn-outs are paid in buyer shares, different tax rules may apply. Specialist advice is essential.

– Use of reliefs: Ensure you qualify for Business Asset Disposal Relief (BADR, formerly Entrepreneurs’ Relief) if available—structure matters!

Key action: Get expert tax advice before agreeing to any earn-out, and model different outcomes so you’re not left with a tax bill on money you never receive.

5. Negotiating a “Seller-Friendly” Earn-Out

– Define metrics precisely: Avoid ambiguity—spell out calculations, timelines, and any exclusions.

– Protect against buyer manipulation: Negotiate limits on major changes to strategy, investment, or staff that could undermine targets.

– Secure partial upfront payment: Don’t put all your value at risk; balance upfront certainty with future upside.

– Plan for disputes: Agree a clear, cost-effective process for handling disagreements.

Final Thoughts: Know Before You Grow

Earn-outs are powerful tools for bridging the gap between seller optimism and buyer caution, but they must be structured with care. The right preparation and negotiation can turn an earn-out from a risky gamble into a lucrative bonus.

Your Exit Starts Here

If you’re wondering whether you’re truly ready to sell, don’t leave it to chance. Take the Exit Readiness Survey today at www.chalkhillblue.org/exitreadiness-survey and get a clear picture of where you stand, and what to do next.

Looking for the complete roadmap to a successful exit? Order The Exit Roadmap by Chris Spratling on Amazon – a practical, step-by-step guide for ambitious entrepreneurs ready to maximise value, minimise stress, and exit on their own terms.

For more insights and real-world advice, follow Chris Spratling on LinkedIn. Start your journey to a successful exit with clarity and confidence.