What is an earn-out?
An earn-out is a contractual mechanism used mainly in mergers and acquisitions, under which part of the purchase price for a company, shares or assets is paid after completion of the transaction. The deferred payment depends on whether the acquired business achieves agreed financial, operational or commercial results during a specified post-closing period.
In practice, an earn-out links part of the seller’s remuneration to the future performance of the business. It is often used where the buyer and seller have different views on the company’s value. The buyer may consider the seller’s financial forecasts too optimistic, while the seller may believe that the current purchase price does not fully reflect the business’s growth potential, customer base, technology, contracts or expected revenues.
An earn-out does not have one uniform legal form under Polish law. Its terms are primarily determined by the share purchase agreement, asset purchase agreement or another transaction document. For this reason, the precise drafting of the mechanism is essential. A poorly structured earn-out may create disputes over accounting policies, management decisions, calculation methods or the buyer’s influence on the acquired business after closing.
How does an earn-out work?
An earn-out clause usually identifies the performance indicators that determine whether an additional payment becomes due. These may include revenue, EBITDA, net profit, gross margin, the retention of key customers, completion of a project, obtaining regulatory approval, commercialisation of a product or achieving other agreed milestones.
The agreement should define the relevant calculation period, the accounting standards to be applied, the data used for verification and the procedure for resolving disagreements. Parties may also agree on a minimum threshold, a maximum amount payable, staged payments or a formula under which the earn-out increases together with the company’s results.
The seller will usually seek protection against actions that could reduce the earn-out, such as transferring key contracts to another group company, changing accounting policies, limiting investment, increasing management fees or discontinuing a profitable business line. The buyer, in turn, will typically expect freedom to manage the acquired company and integrate it with its business. Balancing these interests is one of the most important legal and commercial aspects of earn-out negotiations.
Earn-outs are particularly common in transactions involving technology companies, start-ups, professional services businesses, companies dependent on founders or key employees, and businesses operating in developing markets. They may also be used where a significant part of the company’s expected value depends on future contracts, permits, research outcomes or a successful market launch.
When is legal advice on an earn-out useful?
Legal support is advisable before signing a letter of intent, negotiating the transaction structure or preparing the final acquisition documentation. The parties should establish at an early stage whether the deferred payment is intended to be part of the purchase price, remuneration for continued management services, an incentive arrangement or a combination of these elements. The legal and tax consequences may differ depending on the chosen structure.
For sellers, legal advice can help ensure that the earn-out is measurable, enforceable and not dependent on circumstances controlled exclusively by the buyer. Sellers should also consider reporting rights, access to financial information, audit procedures, payment security and remedies if the buyer fails to calculate or pay the earn-out correctly.
For buyers, advice is important to avoid accepting vague targets, excessive operational restrictions or provisions that interfere with post-acquisition integration. The buyer should assess whether the agreed indicators reflect actual value creation and whether the company’s results can be measured reliably after closing.
A prompt consultation with a lawyer may help prevent unclear payment obligations, accounting disputes, tax risks, conflicts concerning management of the acquired business and financial losses resulting from an unenforceable or poorly documented earn-out arrangement.
Legal support for earn-out arrangements
Law firm support in matters concerning earn-out arrangements may include in particular:
- reviewing the commercial assumptions of an earn-out mechanism;
- drafting and negotiating earn-out clauses in transaction documents;
- defining financial and non-financial performance indicators;
- preparing provisions on accounting principles, reporting and verification;
- advising on the relationship between earn-out payments and management or employment arrangements;
- identifying corporate, contractual and tax risks connected with deferred consideration;
- negotiating buyer and seller protections after closing;
- representing parties in disputes concerning earn-out calculations and payments.
Need legal assistance with an earn-out? Contact us.