Earn-Out in M&A: How to Bridge Company Valuation with Future Performance
In mid-market M&A transactions, earn-outs are one of the most effective tools to bridge valuation gaps, especially where the seller believes in company growth potential that the buyer is not ready to pay for upfront.
In practice, this equity pricing mechanism can account for 10–30% or even more of the total consideration in an M&A transaction, particularly in founder-led companies.
What Is an Earn-Out and When Does It Work Best?
An earn-out is a deferred portion of the equity purchase price, payable only if the acquired business achieves agreed post-closing milestones. Most commonly, these are financial KPIs, such as revenue or EBITDA, although non-financial triggers (e.g. customer acquisition) are also used.
At their best, earn-outs align incentives and allow both parties to “share the future upside”. At their worst, they simply convert today’s pricing disagreement into a post-closing dispute between shareholders.
Earn-outs are more common in sectors where enterprise value is closely linked to the continuity of client relationships, specialist teams or founders’ reputation. This is particularly visible in professional services, IT, distribution, where a meaningful portion of the consideration is often tied to post-closing retention of key clients, partners or employees. In such sectors, the earn-out effectively serves as a mechanism to protect the buyer against the erosion of goodwill and relationship-driven revenues immediately after closing.
The Critical Issue: Control Over Performance During the Earn-Out Period
The single most important practical condition for an earn-out to actually work is seller’s control over the company performance drivers during the measurement period (2-4 years). Therefore, corporate governance rules become a core negotiation point in a company sale with earn-out.
If the founders or selling shareholders remain in operational control — or retain control through a staged sale / deferred acquisition of the remaining stake — an earn-out can genuinely motivate performance.
However, where the buyer takes over decision-making immediately after closing, the seller may be economically exposed to KPIs that are no longer within their control.
At the same time, because meeting those targets increases the deferred consideration for shares, the buyer may have an inherent incentive to influence EBITDA or other KPIs in a way that reduces the earn-out, also because strategic focus is on long-term value creation rather than short-term period performance.
This is why, in practice, protecting the sellers’ position in an earn-out structure requires ensuring that they:
- continue to manage the business,
- retain board or veto rights over key management decisions,
- preserve autonomy i.a. over budget, hiring and commercial policy,
- remain shareholders until the earn-out period expires and/or exercise those rights on the basis of a strong investment agreement / SHA.
Without this governance layer, the earn-out and its expected effects for the seller can quickly become difficult to defend.się trudne do obrony.
A Common M&A Negotiation Point: Should Buyer-Group Revenues and Transaction Synergies Count?
Our practice shows that discussion often arises when the target is to become integrated with the strategic buyer’s group during the earn-out period.
A natural question appears: Should revenues and profits generated from contracts with the buyer, its subsidiaries or redirected customers be included in the earn-out KPIs?
This issue goes directly to the heart of conflicting incentives.
From the seller’s perspective, group-driven revenues may reflect genuine value created thanks to the acquisition platform and therefore should be counted.
From the buyer’s perspective, including such revenues and profits may artificially inflate performance through synergy effects, customer reallocation or intra-group business transfers, rather than reflecting genuine organic growth.
This is why the parties should address these economic issues of organic growth vs. synergy effects explicitly, for example by defining:
- whether intra-group revenues are included, excluded or capped,
- transfer pricing methodology,
- margin recognition rules,
- treatment of shared customers migrated from other group entities,
- allocation of group costs and synergies.
If this is left open, the earn-out formula becomes vulnerable to post-closing equity pricing disputes, rather than aligns interests.
The Practical Rule for Earn-Outs in a Business Sale
The legal drafting matters, but the strategic rule is even simpler: An earn-out should reward future performance that the seller can influence and that both parties can measure without material subjective allocation debates. An earn-out may offer substantial upside to the sellers, but without control rights and a clearly defined KPI calculation methodology, it can easily turn into an unwanted deferred negotiation over the equity price.