Earn-outs: how contingent consideration works

An earn-out is an agreement that part of the price is only paid if the business hits certain targets after the handover — for example a given revenue, gross profit or EBITDA in the first one to three years. It is used when seller and buyer disagree on what the business is worth: the seller believes in the growth, the buyer will not pay for it up front. An earn-out lets them share the risk.

An earn-out can rescue a deal that would otherwise stall, but it is also one of the purchase agreement clauses most likely to end in a dispute. This guide explains how earn-outs are structured, works through an example, and covers the typical pitfalls and the Danish tax questions you need to settle.

When an earn-out makes sense

• Disagreement on value: The seller expects growth that is not yet visible in the accounts — a new product line, new customers or a new market.
• Young or fast-growing business: The track record is short, so the future is hard to price.
• Owner dependency: The buyer wants the seller to help with the transition and the customers to stay.
• Financing: The buyer cannot borrow the full amount, and a contingent payment later eases the pressure on the bank. See financing a business acquisition.

An earn-out is rarely a good idea if the seller leaves completely on completion day, if the buyer plans to merge the business with another, or if the target cannot be measured unambiguously. In those cases a lower fixed price or a vendor loan is often better.

How an earn-out is structured

1. Fixed and contingent parts: Agree how much is paid in cash on completion and the maximum that can be added as earn-out.
2. The target: Choose one clear metric — revenue, gross profit, EBITDA, number of active subscribers — and state exactly how it is measured.
3. The period: Usually one to three financial years after completion. The longer the period, the more the result depends on the buyer’s decisions.
4. The formula: All-or-nothing at a set target, a staircase with several levels, or a linear scale between a floor and a cap.
5. Calculation and payment: Who prepares the figures, when, under which accounting policies, and when is the amount paid?
6. Protection: Rules on how the buyer must run the business during the period, the seller’s right to information, and what happens on a resale, merger or major change.
7. Disputes: Who decides a disagreement — for example an independent accountant acting as expert?

Revenue, gross profit or EBITDA?

As a seller you are usually best protected with a target high up the income statement (revenue or gross profit), because the buyer has less room to influence it. Buyers often prefer EBITDA, because earnings are what create value. A common compromise is gross profit with a clear definition of cost of goods.

Worked example

A webshop is sold for DKK 4.0 million in cash on completion plus an earn-out of up to DKK 1.5 million. The earn-out depends on gross profit in the first two financial years after completion, measured under the same accounting policies as the latest annual reports. The baseline is a gross profit of DKK 3.0 million a year.

The total price in the example is DKK 5,125,000. Note the linear scale: it removes the all-or-nothing effect that tempts the buyer to keep the figure just below the threshold and the seller to push it just above.

The pitfalls

• The buyer changes the business. New prices, different marketing, moving customers to another entity or a merger can lower the figure. Agree how the business is to be run during the earn-out period and what happens if the buyer changes it materially.
• Costs are shifted. Group charges, new management salaries or allocated overheads can squeeze EBITDA. State which costs may be included.
• Unclear accounting policies. Agree that figures are prepared on the same basis as before the sale, and attach a sample calculation.
• The seller loses visibility. Secure the right to see the figures behind the calculation and to have them reviewed by your own accountant.
• Resale. If the buyer sells the business on, the earn-out should either fall due immediately or pass to the new owner.
• Set-off. The buyer may want to set warranty claims off against the earn-out. Decide in advance whether that is allowed.
• Credit risk. An earn-out is a future claim on the buyer. Consider security — such as a bank guarantee or escrow — if the amount is large.

Earn-outs and Danish tax

How an earn-out is taxed depends on how it is drafted. There is no single fixed rule, and the Danish Tax Council (Skatterådet) has dealt with several cases in binding rulings. Broadly:

• Agreed at signing: An earn-out in the original purchase agreement is generally part of the seller’s sale proceeds — in a share deal as part of the gain on the shares, in an asset deal usually as part of the gain on goodwill. If a holding company sells subsidiary shares, the gain including the earn-out may be tax-free.
• Agreed later: The Tax Council has not been able to confirm that an earn-out agreed in a later addendum is part of the sale proceeds. Write the earn-out into the original agreement.
• Periodic payment: In some cases an earn-out can be treated as a periodic payment under section 12 B of the Danish Tax Assessment Act, which affects when and how it is taxed.
• Linked to employment: If payment depends on the seller staying employed, it risks being treated as salary.
• For the buyer: The earn-out increases the price and therefore — in an asset deal — typically the amount that can be written off as goodwill. When it can enter the depreciation base is for the accountant to assess.

Because the whole earn-out may be treated as part of the sale price from the outset, you could end up paying tax on money you have not yet received — and may never receive. Have your accountant assess when the tax falls due, and consider a binding ruling. Read more about tax on selling a business.

Checklist for the earn-out clause

• The fixed price and the maximum earn-out are stated as amounts.
• The target is defined precisely, with accounting policies and a sample calculation as an appendix.
• The period and the payment dates are fixed.
• The buyer’s obligations during the period (operations, changes, resale) are described.
• The seller has a right to information and to have the figures reviewed.
• There is a procedure for disputes, for example an independent accountant.
• Set-off and security have been addressed.
• The earn-out does not depend on the seller’s employment.
• An accountant has assessed the tax for both parties.

How to propose an earn-out on Sitavo

On Sitavo the earn-out can be part of your offer from the start. When you make an offer, the terms let you split the amount between cash on completion, a partial earn-out and vendor financing, adding up to 100%. For the earn-out part you state the share, the period in months and the target — for example «revenue above DKK 2 million in 2027». The seller sees the structure alongside the amount and can accept, decline or counter with a different split. If the seller has chosen a letter of intent for the deal, the structure carries over into it.

The final earn-out belongs in the purchase agreement. Sitavo’s agreements (purchase agreement, asset list and transfer declaration) are free when the seller chooses them for the deal, but they cover a standard transaction. With the Plus deal package, an asset deal gets an extended purchase agreement with optional clauses, where the earn-out and instalments are filled in from the offer. Whatever the paperwork, have a lawyer review the target definitions, accounting policies and information rights before you accept.

Mention the earn-out already in the letter of intent, so it does not come as a surprise late in the process, and write it into the final purchase agreement — see the share purchase agreement or asset purchase agreement. The seller guide chapter on the purchase agreement covers the other clauses, and a Sitavo adviser — such as an M&A adviser, accountant or lawyer — can help negotiate the structure.