Understanding purchase price mechanisms: earn-outs and deferred consideration

Xavier Costa Arnau

RocaJunyent, Barcelona

x.costa@rocajunyent.com

An earn-out is a contingent payment linked to the target’s post-closing results. It allows the seller to receive an additional amount if agreed performance metrics are achieved, aligning part of the price with future success. This differs from deferred consideration, which is an unconditional portion of the price paid over time regardless of performance. Earn-outs are especially common in transactions involving high-growth companies, founder exits or businesses where short-term performance may not yet reflect potential value.

Typical performance indicators include financial measures such as earnings before interest, taxation, depreciation or amortisation (EBITDA), revenue, or gross profit, and sometimes operational milestones such as product launches, customer retention or regulatory approvals. The key is clarity: metrics should be measurable, objective and consistent with the company’s pre-closing accounting principles. Ambiguity here is the main source of disputes.

Because earn-outs depend on how the business is run after completion, they sit at the intersection of control and trust. The buyer generally holds ultimate control of the company, but sellers often retain an operational role or limited decision-making influence to help ensure that earn-out targets are met. The contract must therefore strike a balance that allows the buyer to manage the business while preventing actions that could unfairly hinder the seller’s ability to achieve the earn-out. Clauses requiring both parties to act in good faith and within agreed parameters are common.

These mechanisms can also create natural conflicts of interest. A seller who stays in the company may be tempted to prioritise short-term results to improve EBITDA and secure the earn-out. Acting with a short-term focus is not necessarily negative, but tension arises when decisions are taken solely to maximise immediate profit despite knowing they may harm the company’s longer-term prospects. For example, cutting essential marketing or R&D expenditure might boost short-term earnings but undermine the business’s position once the earn-out period ends. Conversely, sellers often seek assurance that the buyer will not take steps that make it impossible to reach the agreed targets. A well-structured earn-out must recognise both perspectives and align incentives so that value is created sustainably.

Disputes about earn-out calculations are frequent. To manage them, parties often agree that any controversy will be referred to a third-party expert, typically one of the Big Four accounting companies, whose determination is final and binding. This is practical in theory, but in large transactions those companies are often conflicted, either because they advise one of the parties elsewhere or because they audit a related company. In such cases, the process can stall, leaving the parties in limbo until a suitable alternative is agreed.

Earn-outs often coexist with deferred consideration, yet they serve different purposes. Deferred consideration represents a portion of the purchase price that is fixed and payable over time, without depending on future performance. It is usually less contentious, commercially and from a tax perspective, because the amount and timing are predetermined. Earn-outs, by contrast, are conditional payments tied to the company’s results after closing. Their contingent nature introduces greater uncertainty, and when the seller continues to work in the company, tax authorities may question whether part of the earn-out reflects remuneration for personal services rather than payment for the shares. This potential reclassification, from capital gain to employment income, is one of the reasons earn-outs require careful structuring and documentation.

A well-drafted earn-out clause can align expectations and unlock deals that might otherwise stall. A vague one can undermine trust and invite costly disputes. As with most M&A mechanisms, the key lies not only in precision but also in balance. The parties are not adversaries; they have reached an agreement, and the sale purchase agreement and related documents should reflect that understanding in a clear and fair way. When drafting achieves that balance, the mechanism protects both sides and allows the transaction to move forward with confidence.