Understanding Earn-Outs: A Double-Edged Sword in M&A

In the world of mergers and acquisitions, few deal structures generate as much debate and caution as the earn-out. For sellers, it can represent a chance to maximise the final purchase price; for buyers, it acts as a hedge against overpaying. But while earn-outs are often positioned as a compromise, they carry a level of complexity and risk that can make or break a deal both financially and relationally. 

An earn-out is a contractual provision in which a portion of the purchase price is contingent upon the future performance of the business post-acquisition. Instead of receiving the full payment at closing, the seller earns the remaining amount, often over a period of 1 to 3 years if certain performance targets are met. These targets are typically tied to revenue, EBITDA, net profit, or even non-financial KPIs depending on the nature of the business. 

From the buyer's perspective, an earn-out offers a layer of protection. It aligns incentives by ensuring that the seller remains involved and motivated to maintain or grow the business post-transaction. It also minimises the risk of paying for projections that don’t materialise. For example, in cases where the seller makes ambitious growth claims or where the company’s recent performance was unusually strong, the earn-out allows the buyer to base part of the payout on actual outcomes, not projections. 

For sellers, especially those confident in their business’s trajectory, an earn-out can be an opportunity to capture a higher overall valuation. It allows them to bridge valuation gaps, say, when the buyer is sceptical about sustainability of growth. If structured correctly, an earn-out can significantly increase the total proceeds of the sale. In many businesses, this structure also provides a soft landing into exit, allowing the seller to transition leadership and remain involved temporarily while continuing to benefit from the company’s upside. 

However, the challenges begin once the ink dries. Earn-outs are notorious for their potential to create tension between buyer and seller. The most common source of friction lies in the definition and measurement of the performance metrics. EBITDA, for instance, may seem straightforward, but can be heavily influenced by accounting treatments, discretionary expenses, or post-acquisition investments. If not precisely defined in the agreement, disagreements often arise around what qualifies as “earn-out eligible” income or expenses. 

Moreover, after the transaction, the seller typically loses control over key decisions. If the buyer integrates the business, reallocates resources, changes strategy, or prioritises other business lines, it can directly impact the seller’s ability to hit the agreed-upon targets. Even with the best of intentions, strategic shifts or cost allocations within the parent company can dilute the performance of the acquired entity, effectively lowering or eliminating the earn-out payout. From the seller’s point of view, this lack of operational control combined with a financial dependency on future outcomes can be a frustrating, even financially damaging, experience. 

The psychological toll should also not be underestimated. An earn-out creates a continued interdependency between buyer and seller, often after trust has been built under different terms. Misaligned goals, communication breakdowns, or cultural mismatches can escalate small disagreements into larger disputes. What begins as a well-intentioned mechanism to align interests can, if poorly structured, devolve into a source of legal conflict. 

To mitigate these risks, it is essential to design earn-outs with clear, objective, and measurable criteria. Both parties must agree in detail on how metrics will be calculated, what adjustments will be allowed, who has operational control, and what recourse is available in the event of disputes. From a mergers and acquisitions standpoint, we often recommend that earn-outs not exceed 20–30% of the total purchase price and that sellers negotiate for some level of oversight or veto rights on strategic decisions that could materially impact performance metrics. 

In some cases, alternative structures may be more appropriate. A seller notes, retention bonus, or performance-based equity grant can achieve similar alignment without some of the operational entanglements that make earn-outs so fraught. 

In conclusion, earn-outs are neither inherently good nor bad. They are tools, highly useful when employed wisely, and dangerous when misused or misunderstood. For sellers, the key is to weigh the potential upside against the risks and to structure the deal in a way that reflects not just the value of the business, but also the reality of what they can control after the deal closes. For buyers, earn-outs must be used judiciously, with an understanding that a poorly handled earn-out can erode goodwill and damage post-acquisition integration. When trust, clarity, and transparency are baked into the process from the start, earn-outs can unlock value for both sides of the table. 

For any seller preparing to sell their business, engaging experienced M&A specialists early is essential who understand the intricate process of earn-outs. Brookfield Aviation Finance helps aviation businesses build unique process that protects what matters most while positioning your business for a strong, confident exit. 

If you are interested in selling your business contact our team, and they will deep dive and curate strategies for you that will provide a safety net for you and your business at the same time, positioning your business goals as a priority.