Earn-outs bridge valuation gaps between buyer and seller, but poor drafting destroys value. We answer the 12 key questions so sellers never lose the money they were promised.
An earn-out is the piece that saves —or sinks— many business sale transactions in Spain and across Europe. When the buyer offers a price below what the seller expects, the earn-out appears as the bridge: part of the price is paid at closing and part is contingent on the business hitting certain results over the following years. On paper it is an elegant risk-sharing formula. In practice, it is where poorly advised sellers lose the most money.
At Fundenza we advise entrepreneurs who arrive at the earn-out convinced they have closed a great deal, only to discover two years later that 30% of the sale price has evaporated. This article answers the 12 questions every seller should ask before signing the fine print.
What exactly is an earn-out and when is it used?
An earn-out is a clause in the Share Purchase Agreement (SPA) by which part of the price is deferred and made conditional on hitting financial or operational targets over a specific period, typically 12 to 36 months after closing. It is heavily used when:
- Buyer and seller cannot agree on valuation because they disagree on growth projections.
- The company depends on key people —usually the founder— who must stay on for a while after the sale.
- Contracts, clients or pipelines exist that have not yet flowed through into accounting results.
- The sector faces uncertainty and the buyer wants to shift part of the risk to the seller.
In small and mid-cap deals in the Spanish market, between 35% and 50% of transactions include some form of earn-out, and in technology sectors that share exceeds 60%.
Why do buyer and seller almost always disagree on the earn-out?
Because the earn-out shifts the problem rather than solving it. The seller believes they will collect almost everything because "the numbers will go the right way". The buyer designs the clause knowing that once the company is integrated, they will influence many of the variables that determine whether those numbers land.
The classic example: an EBITDA earn-out is agreed, the buyer integrates the company inside a larger group, starts allocating central costs, changes pricing policy or cancels contracts with clients who are also its own suppliers. EBITDA drops, not because of poor management by the seller, but because of legitimate decisions by the buyer. And the seller discovers that the "bonus" is gone.
Which metric should be used: EBITDA, revenue, margins or operating KPIs?
There is no single answer, but there is a clear hierarchy from the seller's point of view.
Revenue
The hardest metric for the buyer to manipulate and the easiest to audit. The downside is that buyers rarely accept it, because it does not reflect profitability.
Gross margin
A good balance: it captures profitability but excludes general overhead that the buyer can inflate through group cost allocation. Often the best negotiated option.
EBITDA
The most common metric and the most dangerous for the seller if it is not precisely defined. Never accept an EBITDA earn-out without a detailed annex freezing the accounting policies that apply during the period.
Operating KPIs
Active customers, renewal rate, MRR in SaaS models, units sold. Useful as a complement, but rarely as the sole metric.
How large should the earn-out be relative to the total price?
The rule we apply at Fundenza is simple: the earn-out should be the bonus, not the salary. If the upfront price alone does not cover the minimum acceptable value for the seller —what we call the "price floor"— the deal is not ripe.
As guidance for Spanish SMEs:
- Earn-out below 20% of the total: comfortable, low-conflict, common when the seller does not stay on.
- Between 20% and 35%: reasonable range when the seller stays and there is a clear transition plan.
- Above 35%: risk zone. The seller is financing the buyer and taking on operating risk they no longer fully control.
- Above 50%: this is not a sale, it is a partnership dressed up as a purchase. Rethink the structure.
What duration is reasonable and why does it matter so much?
A long earn-out nearly always hurts the seller. The longer it runs, the more decisions the buyer makes that affect the outcome and the less ability the seller has to defend it. In the Spanish market the reasonable range is 12 to 24 months. Three years is the upper bound; four years or more is only justified in very large deals with long-cycle customers such as defence or infrastructure.
Duration also drives tax treatment, buyer accounting and the seller's engagement with management: the longer the period, the more dangerous the conflict of interest.
How does the seller stay protected when the buyer controls the business?
This is where earn-outs are won or lost. A good contract includes:
- Ordinary course of business obligation: the buyer commits to running the company according to good practice and in line with its historical activity.
- Business line protection: no reassignment of customers, products or contracts to other subsidiaries during the earn-out.
- Accounting freeze: depreciation, provisioning and revenue-recognition policies used in the base year stay in force through the earn-out.
- Monthly auditable reporting: the seller receives closed financials, with access to the books to verify.
- Earn-out committee: a joint body of two people per side that resolves disputes before arbitration.
Which anti-manipulation clauses are non-negotiable?
We consider three clauses non-negotiable for any seller:
- Ban on artificial cost allocation: the buyer cannot load group overhead, central services or management fees that did not exist before the deal.
- Acceleration clause: if the buyer sells, merges or materially changes the perimeter of the company during the earn-out, the full amount is paid out immediately at the maximum possible level.
- Independent expert resolution: any dispute over earn-out figures is resolved by an accounting expert appointed by agreement, not by court arbitration, which is slower and more expensive.
How does the earn-out affect the seller's Spanish tax position?
Earn-out taxation is a technical area that deserves a specialist adviser, but the outline is clear.
If the seller is an individual selling shares in a Spanish company, the capital gain is taxed under IRPF at closing. The earn-out can be treated as deferred consideration and taxation postponed to the year of receipt, provided it is properly documented in the SPA. This can help or hurt depending on the marginal rate expected in future years.
If the seller is a holding company, the participation exemption under article 21 of the Spanish Corporate Income Tax Act can apply to 95% of the amount received, earn-out included, provided minimum ownership and holding-period conditions are met.
Common trap: if the earn-out is disguised as salary compensation to the seller in the following years —such as a "retention bonus"— the Spanish tax authority can reclassify it as employment income, with much higher marginal rates. Documenting the true nature of the payment is essential.
What happens if the seller leaves before the earn-out is over?
It depends on how the "good leaver / bad leaver" clause has been drafted. A well-negotiated contract distinguishes three scenarios:
- Objective departure (serious illness, death, retirement at the end of the term): the seller keeps the full earn-out right, on a pro-rata or total basis as agreed.
- Voluntary exit: the seller loses the pending portion, with a possible clawback.
- Termination for cause: total loss. Here it is critical to define what "cause" means so the buyer cannot use it as leverage.
And if targets are missed for reasons outside the buyer's control?
Markets, macro shocks or a key client going bankrupt are external risks. The standard clause shifts them to the seller, who ends up unpaid. A good contract includes earn-out adjustments for extraordinary events: regulatory changes, pandemics, loss of a client representing more than 20% of revenue for reasons not attributable to the seller.
These adjustments are negotiated case by case and became especially relevant after 2020-2021, when many pre-Covid deals ended up in litigation over earn-out breaches.
What is an earn-out actually worth on signing day?
From the seller's perspective, the expected value of an earn-out is not its maximum amount but its maximum amount adjusted for probability of collection. Our internal statistics on Spanish SME transactions closed in the last five years show that on average the seller collects:
- 85%-95% of the earn-out when the metric is gross margin and the seller stays in management.
- 60%-75% when the metric is EBITDA without strong anti-manipulation clauses.
- Less than 50% when the seller exits at closing and the earn-out depends on results more than two years out.
Applying this discount before signing is what separates a rational decision from an emotional expectation.
Frequently asked questions about earn-outs
Can the earn-out be cashed in early?
In some cases yes, through a monetisation transaction with a bank or specialist fund, but at discounts that typically range from 20% to 40% off the nominal amount.
Are earn-outs common in private equity deals?
Yes. PE funds use earn-outs systematically to align the seller with the value-creation plan. They tend to be more aggressive on targets and more professional on documentation.
Can I negotiate an earn-out with a guaranteed minimum floor?
Yes. The "floor + earn-out" structure secures a minimum share of the deferred amount for the seller and only puts the rest at risk. It is recommended when the seller exits at closing.
What minimum reporting must the buyer deliver?
Quarterly closed accounts, an auditor's report on the earn-out calculations at year-end and access to working papers. Any pushback from the buyer here is a red flag.
Do I need a specialist adviser or is my usual lawyer enough?
A general corporate lawyer can draft the clause, but rarely has hands-on experience of how earn-outs actually behave in M&A. A specialist adviser in business sales is the one who spots the traps before signing.
At Fundenza we support Spanish entrepreneurs across every stage of selling their company, from initial valuation to closing and earn-out follow-up. Getting this clause right can mean collecting 90% of what was agreed rather than 40%.
