Earn-Out in M&A: What It Is, How It Works, and Practical Examples

An earn-out is one of the most widely used payment mechanisms in mergers and acquisitions (M&A). When the buyer and seller can't agree on the final price, this clause lets them tie part of the payment to future targets and close the deal on terms both sides can accept.

In this guide, we explain exactly what an earn-out is, how it works with a practical example, when it's used, which milestones are usually agreed, and what its advantages and risks are for each party.

What is an earn-out

An earn-out is a clause in the purchase agreement (SPA) stating that part of the price is paid on a deferred and contingent basis, depending on whether the acquired company meets certain milestones in the months or years after closing.

In other words, the buyer pays a fixed amount at closing (upfront payment) and commits to paying an additional amount if the company hits certain targets (revenue, EBITDA, margins, commercial milestones, etc.) over a subsequent period, usually two to five years.

This structure is used to bridge valuation gaps: when the seller believes the business is worth more than the buyer is willing to pay, the earn-out lets the seller "prove" that value through future results, while the buyer limits its initial risk.

How an earn-out works: a practical example

A typical earn-out structure has three elements:

1. Upfront payment: a fixed amount the buyer pays at closing.
2. Contingent deferred payment: a variable amount paid if the agreed milestones are met.
3. Measurement mechanism: objective indicators to verify whether the milestones are met (audited EBITDA, certified revenue, etc.).

📊 Numerical example

Let's imagine a company whose valuation is in dispute:

1. Seller asks for: €5,000,000
2. Buyer offers: €4,000,000
3. Gap: €1,000,000

Instead of walking away from the negotiation, both parties agree on an earn-out structured as follows:

1. Payment at closing (upfront): €4,000,000
2. Deferred payment tied to EBITDA over the next 3 years: up to an additional €1,000,000
3. Milestones: €333,000 is paid for each year in which the company reaches a minimum EBITDA of €500,000

With this structure, if the company meets expectations, the seller receives the €5M they asked for. If it doesn't, the buyer pays only what the business actually justifies. Both parties take on a controlled level of risk.

When an earn-out is used

1. Valuation gaps between the parties

This is the most common case: the seller and buyer can't agree on the price. The seller is confident in the company's future potential; the buyer is more cautious. The earn-out closes the gap by tying the difference to actual results.

2. Companies with a short track record or volatile results

When a company has only a few years of operating history or has gone through a period of highly variable results, traditional EBITDA multiples become less reliable. An earn-out allows part of the valuation to be based on future performance.

3. Deals where the seller's continued involvement is key

In owner-centric businesses (where the owner holds a critical leadership position), an earn-out ensures the seller stays on during the transition period and aligns their incentives with the buyer's.

4. Companies undergoing restructuring or in disruptive sectors

If the company is going through a transformation, a difficult period, or operates in a very new sector (deep tech, AI, sustainability), the earn-out acts as a risk-hedging mechanism for the buyer.

Which milestones an earn-out is tied to

Earn-out milestones must be objective, measurable, and verifiable. These are the most commonly used in real deals:

1. EBITDA: the most common. It's verified annually with audited financial statements.
2. Revenue: useful when the business isn't profitable yet but is growing fast.
3. Gross margin or operating margin: ideal for companies that are scaling up.
4. Commercial milestones: signing key contracts, launches, certifications, etc.
5. Retention of key customers or employees: relevant for companies with intangible assets.
6. Operating indicators: output, efficiency ratios, quality metrics.

⚠️ Key warning: milestones must be defined with extreme precision in the SPA, specifying how they're calculated, who verifies them, and what happens in the event of a dispute. Disputes over whether milestones have been met are one of the main sources of post-closing litigation in M&A.

Frequently asked questions about earn-outs

What percentage of the total price is usually the earn-out?

The earn-out usually represents between 10% and 30% of the total deal price. Above 30%, sellers tend to push back, since they'd be taking on too much risk tied to the buyer's future management. Below 10%, it no longer serves its purpose of bridging valuation gaps.

How long does an earn-out usually last?

The typical term is two to three years, although it can extend to five years in complex deals. A term that's too short doesn't allow the business's sustainability to be properly verified; one that's too long increases risks and disputes.

What happens if the company doesn't hit the milestones?

If the milestones aren't met, the buyer doesn't pay the deferred amount (or pays only the proportional part). That's why it's critical to define milestones realistically and precisely and to provide for intermediate scenarios (partial payment, adjustment mechanisms, carve-out clauses for external causes).

Are disputes common during an earn-out?

Yes, disputes are one of the main sources of post-closing litigation. They usually arise from discrepancies in how EBITDA is calculated, management decisions by the buyer that affect results, accounting changes, or investments that reduce profit. That's why it's essential to agree on dispute resolution mechanisms (external audit, arbitration) in the SPA.

Can the seller keep running the company during the earn-out?

Yes, and in fact it's common practice. Keeping the seller on the management team during the earn-out aligns incentives and increases the likelihood that the milestones will be met. The terms of their continued involvement (role, salary, autonomy) are agreed in the SPA.