Structuring an Earn Out Deal: Sharing Risk and Reward

Earn out deals have become increasingly common in partial sales and strategic partnerships. They can bridge a valuation gap, align incentives, and give both parties confidence that value will be delivered. They can also create friction and uncertainty if drafted poorly. An earn out is not a shortcut. It is a disciplined way to share risk and reward when the future performance of the business is a key part of the deal rationale.

For business owners considering a partial sale or a staged exit, understanding how earn outs work – and how to structure them properly – is essential. At Mergers.co.uk, we help owners design deals that protect legacy, secure upside, and establish a long-term partnership built on shared growth.

What an Earn Out Actually Is

An earn out is a contractual agreement where part of the consideration is paid after completion, based on the future performance of the business. It ties the seller’s future payout to measurable results. Earn outs are particularly useful when:

• The buyer and seller disagree on future growth.

• A founder is remaining in the business for a period.

• The buyer wants assurances that current performance will continue.

• A partial sale is being used to accelerate growth.

When used correctly, the earn out turns uncertainty into a shared opportunity.

Why Earn Outs Are Common in Strategic Partnerships

A strategic partner buying a stake in a business wants to ensure the existing management remains committed and that performance does not decline post-transaction. Earn outs offer:

• A mechanism to align motivation.

• A fair method to reward delivery.

• A safeguard against overpaying.

• A route to bridge valuation differences.

This is particularly relevant to the Mergers.co.uk model, where the goal is not an immediate full exit but a staged journey towards a significantly larger end value.

Key Elements of a Well-Structured Earn Out

A strong earn out structure protects both sides. It should be clear, measurable, and free from ambiguity. The core components include:

1. Performance Metrics

The most common metrics are:

• Turnover

• Gross profit

• EBITDA

• Net profit

EBITDA is often preferred as it is less vulnerable to distortion. The chosen metric must be simple and transparent.

2. Earn Out Period

Typical periods range from one to three years. In strategic partnership structures, two or three years is common to give enough time for meaningful growth.

3. Seller’s Influence and Role

If a seller is expected to deliver against a target, they must retain the appropriate authority, budget, and operational responsibility. Buyers who restrict decision-making risk undermining their own earn out.

4. Calculation and Payment Terms

Earn out formulas must be precise. Common methods include:

• Fixed percentage of EBITDA above an agreed baseline.

• Tiered payouts for hitting specific milestones.

• A sliding scale to balance risk and reward.

Payments are usually annual, though some structures use quarterly payments for clarity.

5. Protections and Safeguards

Both parties should expect sensible protections, such as:

• Defined accounting standards

• Restrictions on extraordinary costs

• Agreed investment plans

• Clear dispute resolution processes

Ambiguity is the enemy of a healthy earn out.

Benefits for Both Sides

A well-designed earn out aligns risk and reward. The advantages include:

• Reduced upfront consideration for the buyer

• A higher total return for the seller if performance exceeds expectations

• Maintenance of performance stability after a transaction

• A shared mindset around growth

In partial sales, earn outs help create a true partnership – the original owner retains influence while gaining the resources, capital, and expertise of a new strategic partner.

Common Pitfalls to Avoid

Poorly drafted earn outs can be destructive. The most frequent issues are:

• Vague definitions and unclear metrics

• Unrealistic growth expectations

• Misaligned incentives between buyer and seller

• Accounting manipulation, intentional or otherwise

• Changes in strategy or control without appropriate safeguards

A good earn out is built on clarity, fairness, and proper legal and financial advice.

Earn Outs in Partial Sales: A Practical Example

Consider a business valued at £6 million. The buyer acquires 60 percent for £3 million at completion. A further £1.5 million is linked to an earn out over three years based on EBITDA growth. If the business hits the growth milestones, the seller receives the £1.5 million and retains their remaining 40 percent equity, which is now worth significantly more due to the increased valuation.

This is the essence of the Mergers.co.uk approach: share risk, share upside, and build a bigger future exit over time.

When an Earn Out Is the Right Tool

Earn outs work best when:

• The founder plans to stay on for the medium term.

• The valuation relies heavily on projected growth.

• A strategic partner is joining to fuel expansion.

• There is mutual trust and long-term alignment.

If the seller wants a clean break or the buyer expects to overhaul the business immediately, an earn out is rarely appropriate.

Earn outs are powerful when used correctly. They balance risk, reward strong performance, and help bridge valuation gaps. In strategic partnerships, they support a long-term collaborative journey rather than a one-time transaction.

At Mergers.co.uk, we specialise in structuring staged exits and partial sales that align incentives, protect legacy, and maximise the ultimate value for business owners. If you are exploring a partnership-led exit or want to understand whether an earn out could work for your business, we can help.

Contact us today.