Learn how to structure, negotiate and manage an earn-out in a business sale. From choosing the right metric to protective clauses in the SPA, a practical guide with real M&A data.
An earn-out is one of the most powerful — and most misunderstood — mechanisms in business acquisitions. When buyer and seller cannot agree on price because the business has a promising but uncertain future, an earn-out bridges the gap: part of the purchase price is paid at closing, and the rest is contingent on the company hitting agreed performance targets. This step-by-step guide explains how earn-outs work, when they make sense, and how to structure them so they don't become a source of costly disputes.
In the Spanish M&A market, earn-outs are particularly common in two scenarios: the sale of fast-growing technology or service businesses where current EBITDA understates future potential, and family business transitions where the buyer needs the founder to stay on for a handover period. According to Fundenza's internal data, over 35% of M&A transactions involving Spanish SMEs with EBITDA between €1M and €10M include some form of deferred consideration mechanism.
What is an earn-out and why it can unlock a business sale
An earn-out is a deferred pricing mechanism: a portion of the purchase price is not paid at closing but is instead contingent on the business achieving specific performance milestones in the months or years that follow. The buyer pays less on day one, reducing their risk. The seller receives the balance if the business performs as promised. What looks simple on paper can become fiendishly complex in practice — which is exactly why getting the structure right from the start matters.
Step 1 – Assess whether your deal is a candidate for an earn-out
Not every deal benefits from an earn-out. Before accepting or proposing one, consider the following factors:
Signs that an earn-out could be the solution
- A meaningful valuation gap: Buyer and seller are more than 20% apart on price, and the gap stems from different views on the future rather than on historical facts.
- A business in rapid growth: The company has grown over 20% annually for the past two years and the buyer questions whether that trajectory is sustainable.
- Pending contracts or pipeline: There are significant tenders or deals in progress that could materially change results over the next 12-24 months.
- The seller stays on: The owner will continue to manage the business after closing, making it reasonable to link part of their return to future performance.
Signs that an earn-out is the wrong tool
- The seller wants a clean break and full exit at closing.
- The sector is highly cyclical and results depend more on macroeconomic conditions than on management.
- The buyer plans deep operational integration that makes it impossible to isolate the acquired business's performance.
- There is no robust financial reporting system to measure the agreed metrics reliably.
Step 2 – Choose the right performance metric
The choice of metric is arguably the most important decision in the whole process. A poorly chosen metric is the seed of future conflict. The golden rule is straightforward: the harder the metric is to manipulate and the more directly it reflects value creation, the better.
EBITDA, revenue, or cash flow: what works and what doesn't
- Adjusted EBITDA: The preferred metric when the seller remains in day-to-day management. Its main risk is accounting manipulation — deferring expenses to inflate EBITDA during the earn-out period.
- Revenue: Easier to measure and harder to manipulate than EBITDA, but it says nothing about profitability. It can incentivise the seller to accept low-margin work just to hit the threshold.
- Operating cash flow: The most robust metric and the hardest to manipulate. Ideal when the buyer will have limited influence over post-closing management.
- Operational KPIs: In tech or professional services businesses, linking the earn-out to active customer count, retention rate, or ARR often reflects value creation more accurately than accounting metrics.
Fundenza's recommendation: define the metric with surgical precision in the contract. Writing "EBITDA" is not enough. You must specify whether it is consolidated or ring-fenced to the acquired perimeter, how extraordinary items are treated, how intercompany transactions with the buyer's group are handled, and who has the final say in the closing audit.
Step 3 – Negotiate the key earn-out parameters
Once the metric is agreed, the next step is to set the parameters that convert a number into money. The three fundamental elements are the amount, the period, and the payment structure.
Amount, period and payment structure
In the Spanish M&A market, an earn-out typically represents 15% to 35% of the total deal value. Below 15%, the incentive for the seller is insufficient. Above 40%, the risk becomes unacceptable and can kill the deal.
The standard duration is 12 to 36 months from closing. For businesses with long sales cycles — industrial engineering, B2B software with multi-year contracts — a 24-36 month period makes more sense than a 12-month window.
There are two main payment structures:
- Binary: Hit the target and receive the full earn-out; miss it and receive nothing. Simple to document but creates perverse incentives — the seller may take excessive risks to cross the threshold.
- Graduated (ratchet): The earn-out accrues proportionally to results, with a guaranteed floor and a contingent ceiling. More complex to draft but fairer for both sides and far less prone to disputes.
Our recommendation is always the graduated structure, with a minimum guaranteed payment for the seller even if results fall slightly below the primary target.
Step 4 – Draft the earn-out clause in the SPA with minimum room for dispute
An earn-out agreed in principle can become a trap if not drafted precisely in the Share Purchase Agreement. These are the points that must be included:
Protective clauses for the seller
- Non-interference covenant: The buyer cannot change the cost structure, senior management team or commercial policy of the acquired business without the seller's consent during the earn-out period.
- Information rights: The seller must have monthly or quarterly access to management accounts during the earn-out period.
- Dispute resolution mechanism: Agreeing on an independent accountant or expert determination process before any dispute arises is far more efficient than litigation after the fact.
- Acceleration clause: If the buyer sells the business before the earn-out period ends, the outstanding balance becomes immediately payable.
Step 5 – Actively manage the earn-out period
The earn-out doesn't end when the SPA is signed — it begins. For the seller who remains in the business, the earn-out period is a second chapter of entrepreneurship, but now without full ownership of what they built. That dual identity needs active management.
- Document everything: Every buyer decision that could affect the metrics must be recorded in writing. That is your protection in any future dispute.
- Hold regular review meetings: A monthly KPI review with the buyer is far more productive than a confrontational annual conversation.
- Protect your key team: Staff turnover during the earn-out period is one of the strongest predictors of missing targets.
- Watch for intercompany transactions: If the buyer starts allocating corporate overhead to the acquired business or diverting customers to other group subsidiaries, activate the SPA's protective clauses immediately.
Step 6 – Close the earn-out: final audit and settlement
At the end of the earn-out period, the buyer typically has 30-60 days to prepare a calculation of the final metric. The seller then has a review period — usually 20-30 business days — to accept or challenge it. If there are disagreements, the dispute resolution mechanism agreed in the SPA comes into play.
In practice, most earn-out disputes in Spain are resolved through direct negotiation before reaching the independent expert. The reason is simple: an arbitration process can cost as much in fees and management time as the disputed amount itself.
Frequently asked questions about earn-outs in business sales
How is an earn-out taxed?
Each earn-out payment is treated as additional consideration for the sale of the business and taxed as a capital gain (for individuals) or as corporation tax income (for corporate sellers) in the tax year the payment becomes due.
What happens if the buyer becomes insolvent during the earn-out period?
The earn-out claim ranks as an unsecured creditor. To protect against this risk, sellers should negotiate a bank guarantee, an escrow deposit, or security over the buyer's assets in the SPA.
What proportion of earn-outs end in dispute?
International M&A research consistently finds that 30-40% of earn-outs result in formal disputes or arbitration. The best prevention is precise contractual drafting and a pre-agreed dispute resolution mechanism.
Can the seller negotiate a guaranteed minimum earn-out?
Yes, and this is one of the most frequently negotiated points. A floor guarantee — typically 30-50% of the maximum earn-out — makes the structure more acceptable to the seller without eliminating the buyer's protection entirely.
Can earn-outs be paid in shares rather than cash?
Yes, particularly when the buyer is a company able to issue equity. This can offer tax advantages if rollover or deferral relief is available, but it introduces additional risk: exposure to the buyer's share price during the earn-out period.
