Understanding Earn-Out Agreements: What UK Businesses Need to Know Before a Sale

Thinking of selling your small business, or perhaps planning an acquisition and wondering about the best way to bridge a gap between what you think your business is worth and what the buyer is prepared to pay? You’re not alone - this is where an earn out can really come into play. But before you shake hands on a deal, it’s vital to understand exactly how earn-outs work in the UK, what common pitfalls to watch for, and how to make sure you’re legally protected from day one.

In this guide, we’ll break down what an earn-out is, when it’s used, how it’s structured, and what you’ll need to ensure any deal is fair and watertight. If you want to avoid costly mistakes and set yourself up for long-term success, keep reading.

What Is an Earn Out?

An earn out is a common arrangement when selling or buying a business, especially when both sides have differing views about the business’s current value or future potential. Put simply, an earn-out means part of the purchase price is deferred - the seller will receive additional payments based on the business meeting specific performance targets after the sale closes.

It’s a way to bridge the value gap and align incentives. The buyer only pays the higher price if the business performs as well as (or better than) expected. The seller, often staying on to help run the business for a period, can prove the business’s true earning potential.

• For sellers, it's a chance to secure a higher overall price, provided targets are realistic and achievable.
• For buyers, it limits risk by ensuring extra payment only happens if the business delivers the results promised.

But - and it’s a big but - earn-out agreements can get complex quickly. Poorly drafted terms, ambiguous targets, or unforeseen disputes can leave both parties feeling short-changed. That’s why knowing the ins and outs is essential before signing on the dotted line.

When Are Earn Out Agreements Used in the UK?

You’ll often see earn out deals in these scenarios:

• Growth businesses: Startups with lots of future promise but limited historical profits.
• Family businesses: Sellers planning to step back gradually and buyers who don’t want to pay full value upfront.
• Specialist small businesses: Where ongoing management input from the founders is vital to maintain value.
• Disagreement over value: Buyer and seller can’t agree on what the business is “worth” today.

If either party wants to tie future payouts to business performance, an earn out is likely to be on the table.

How Does an Earn Out Work? Key Features and Structures

No two earn-out agreements are exactly the same, but most follow a similar pattern:

• Initial payment: A portion of the sale price is paid upfront on completion (“day one payment”).
• Deferred consideration: The rest is paid in instalments, often over 1-3 years, IF specified targets are hit (these instalments are the earn-out).
• Performance targets: These could include revenue, profit, EBITDA, customer numbers, or other financial/non-financial KPIs.
• Seller involvement: The former owner(s) usually stay on in a management role during the earn-out period to help ensure success.

The earn-out might be structured as:

• A simple cash sum per period if targets are met
• A percentage of profit or sales
• Tiered payments if “stretch” targets are achieved

It’s easy to see the potential advantages. But there are also plenty of places where things can go wrong if the agreement isn’t drafted with care.

Why Are Earn Outs Tricky? Common Risks and Disputes

Earn outs are famously a source of dispute after business sales. Why? Because the buyer and the seller’s interests aren’t always perfectly aligned after completion. Here’s where problems often arise:

• Ambiguous targets: If the measure of success isn’t crystal clear, there’s scope for disagreement.
• Manipulation of results: A new owner might change how profits are calculated, or divert revenue/expenses, meaning targets are missed even if the business is healthy.
• Lack of control: Sellers may have limited say in how the business is run after sale, but their earn-out depends on performance.
• External events: Covid, economic downturn, or other factors can hit results, leaving sellers out of pocket through no fault of their own.
• Tax considerations: Earn-out payments have their own UK tax treatment - get advice to avoid surprises.

Minimising these risks means careful planning, negotiation, and (most importantly) robust legal drafting.

What Should Be Included in an Earn Out Agreement?

Every earn out should be tailored to the specifics of the business and deal. But some key things to nail down in your sale agreement or a dedicated earn-out schedule include:

• What targets apply? Be precise: financial metric, time period, and method of calculation.
• Who controls the business post-sale? Spell out if the seller keeps any management rights or veto power.
• How are targets measured? Who prepares the accounts? Can the seller see management accounts regularly?
• Adjustment for extraordinary events: What happens if there’s a major change in the market or customer loss?
• Restrictions on the buyer: To stop the new owner taking actions that would unfairly reduce the earn-out.
• Dispute resolution process: If there’s a fallout, how will disputes on earn-out payments be settled (e.g. arbitration, mediation)?
• What happens if the seller leaves early? (resignation or dismissal)
• Tax clauses: How and when HMRC gets involved in the payment process.

It’s vital that both sides understand and agree on the core contract terms to avoid ambiguity and disappointment later. Avoid using generic templates or drafting these agreements yourself - they must be tailored to your business and this specific transaction.

How Are Earn Out Payments Calculated?

This is where the devil is in the detail. Typical methods include:

• Revenue-based earn outs: The seller receives a percentage of total sales above a certain threshold each year.
• Profit-based earn outs: The earn out is linked to EBITDA or net profit calculated under agreed accounting rules.
• Non-financial metrics: Sometimes, targets are based on things like new customers, product launches, or even securing regulatory approvals.

Whatever the basis, it’s crucial for your earn-out agreement to clearly define exactly how these figures are calculated (and who has the final say if there’s a dispute). If you want an enforceable, future-proof contract, talk to a legal expert who understands both business sales and accounting standards.

What Legal Documents Do I Need for an Earn Out?

Your main legal document will typically be a Business Sale Agreement that contains a detailed earn-out schedule or annex. Often, the specifics of the earn out are set out in a separate schedule to avoid cluttering the main agreement with complex calculations.

Other relevant documents and steps include:

• Company valuation reports (to set expectations upfront)
• Due diligence checklists
• Supplier and customer agreements (continued relationships may impact results)
• Tax advice documents (earn-outs can affect your capital gains tax and reporting to HMRC)

It’s also smart to make sure any share issue or transfer agreements line up with the possible outcomes of the earn-out for everyone involved.

How Can I Protect Myself in an Earn Out?

There are a few golden rules to keep yourself protected, whichever side of the deal you’re on:

• Get advice early: Specialist lawyers and accountants should review, negotiate, and draft all paperwork.
• Agree metrics in plain English: Avoid jargon or undefined terms (“profit” can mean different things to different people!).
• Set clear reporting obligations: If you’re the seller, push for regular accounts, audit rights, and visibility over business decisions.
• Build in dispute resolution: Decide how disagreements will be handled BEFORE there’s a problem.
• Consider security for payments: Bank guarantees, retention amounts, or escrow can help reduce the risk of not getting paid.
• Don’t sign a template: Your business (and your risks) are unique. A bespoke contract is essential.

It can be tempting to focus just on the headline sale price, but the detail of your earn-out terms will have the greatest impact on the true final value you receive. Make sure your legal documentation matches your intentions - and your best interests.

Key Laws to Be Aware Of with Earn Outs

In the UK, earn out agreements and business sales are subject to a range of laws and regulations. Some of the most important areas include:

• Contract Law: Make sure agreement terms are clear, complete, and legally enforceable under English law.
• Employment Law: If the seller is staying on as an employee during the earn-out period, both parties must comply with employment regulations and duties. Our guide to UK employment laws provides a good overview.
• Taxation: Both capital gains tax and income tax may apply to earn-out payments. HMRC rules can be complex, and missed steps can mean unnecessary tax liabilities.
• Data Protection: Ensure continued management of customer and employee data meets GDPR and Data Protection Act 2018 requirements during and after the earn-out period.
• Competition Law: Any restrictive covenants or exclusivity clauses in an earn-out must comply with UK competition law.

If you’re unsure whether your plans comply, expert advice is always a wise move - and can prevent legal disputes down the track.

What Happens If There’s a Dispute Over an Earn Out?

No one goes into a business sale expecting a dispute, but they do happen. If you can’t agree on whether a target has been met, or if one side feels the other isn’t holding up their end, your earn-out agreement should specify:

• The dispute resolution procedure (negotiation, mediation, independent expert, arbitration, or court)
• The method for calculating or adjusting disputed payments
• Any processes for appealing or reviewing outcomes

Having these steps in writing will make any disagreement quicker and less costly to resolve. For a deeper dive into this area, see our guidance on arbitration and contract disputes.

Are Earn Outs Right for My Business Sale?

Earn-outs can be an excellent tool to unlock the full value of your business and get a deal over the line, especially when sellers and buyers can’t quite agree on value. But they aren’t right for everyone.

Earn outs work best when:

• The seller will stay involved for a significant period after the sale
• Both sides have similar expectations for future performance and can agree what success looks like
• Key performance metrics can be measured simply and transparently
• There is mutual trust and willingness to work together during the earn-out period

If you’re thinking about structuring a sale this way, talk to a lawyer early on. They’ll help you negotiate fair terms, spot risks, and draft a contract that really protects your interests as the business changes hands.

Key Takeaways

• An earn out links a portion of a business sale price to future performance targets, helping smooth out sale negotiations.
• They are most common where there’s disagreement over value or a business’s future growth is crucial to its worth.
• Clear earn-out contracts should include specific targets, measurement methods, management rights, dispute procedures, and payment structures.
• Poorly drafted earn out agreements can lead to confusion, disputes, and financial loss - always seek legal and tax advice before signing.
• All earn out arrangements should be bespoke, reflecting your business’s unique situation and risks.

If you’re planning to buy or sell a business and want to structure a fair and effective earn-out, don’t leave things to chance. Contact our friendly legal experts for a free, no-obligation chat on 08081347754 or team@sprintlaw.co.uk - we’ll help you protect your interests and negotiate the best possible deal for your future.