Earn out

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What an earn out does

An earnout separates some of the purchase consideration from the amount paid at completion. The later amount is conditional on a defined outcome over a defined period. The outcome might relate to revenue, earnings, customer retention or another agreed measure. The exact agreement determines whether a payment is earned.

A seller may believe a growth opportunity will produce more value than the buyer is willing to pay for immediately. An earnout can share that uncertainty. It also leaves the seller exposed to future performance and, often, decisions the buyer controls. It should be assessed as a distinct risk, not treated as cash already received.

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Earnout vs vendor finance

Fixed deferred consideration is payable under agreed terms even though payment happens later. An earnout is contingent on the agreed outcome. Vendor finance usually involves the seller funding part of the purchase with repayment terms; it is not automatically an earnout. A transaction can contain more than one of these elements.

Set out cash at completion, fixed later payments and contingent payments separately. Consider the buyer's ability to pay as well as the formula. A successful performance result is not the same as having the cash available to make the payment.

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A hypothetical earn out calculation

Suppose the parties agree a $1 million payment at completion plus an earnout equal to twice the amount by which the next year's agreed EBITDA exceeds $300,000, capped at $200,000. For this simplified illustration, amounts below the threshold earn no payment.

This is an invented NZD example to explain the mechanics, not a recommended price, multiple or contract. A real agreement may use a different threshold, sliding scale, period or payment structure.

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Define the measure before negotiating the target

A revenue target may encourage sales that have poor margins. An earnings target depends on cost allocation and accounting treatments. Customer-retention measures need rules for account grouping, renewals and partial losses. Start with the commercial outcome, then test whether the proposed measure captures it fairly.

For EBITDA, define the permitted earnings adjustments, accounting policies, intercompany charges, owner remuneration and exceptional items. Specify the period and treatment of revenue recognition, bad debts and returns. Worked examples at the threshold, cap and unusual cases can expose ambiguity before signing.

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What to settle in an earnout agreement

Identify who controls pricing, staffing, investment and integration during the earnout period. Consider what happens if the buyer changes the business model, transfers customers or combines operations. The seller's continuing role should be clear, including decision authority and any employment arrangements.

• Who prepares the performance calculation, and when?
• What records can the other party inspect?
• How long is allowed for questions or objections?
• How are disputed calculations resolved?
• What happens if the business is sold again or closes?
• When is payment due once the amount is agreed?

These are commercial questions to take to the transaction's legal and tax advisers. The wording and tax consequences depend on the actual arrangement.

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Test whether the structure fits your exit

Model a low, middle and high result without treating the middle case as certain. Compare the timing and risk with a lower cash offer. If you want a clean exit, several years of performance involvement may conflict with that goal. If you stay, agree how you can influence the measures on which your payment depends.

Our selling a business in NZ guide connects price terms with preparation, diligence and handover. We help owners consider the commercial trade-offs alongside the broader ownership transition.