Earn-Outs: When the Second Payment Actually Arrives

The ProtectionWhat the buyer is actually protecting against

An earn-out is not a negotiating tactic, whatever it feels like across the table. It is the buyer covering three specific risks: that contracts do not renew once your name comes off the paperwork, that the largest clients were really buying you rather than the business, and that the trading figures they have been shown do not repeat. In a contract business those are reasonable things to worry about.

That tells you how to reduce it. Every piece of preparation that makes renewal look inevitable reduces the amount a buyer needs to hold back: signed contracts with clear terms, documented service history, named technicians owning the client relationships, low client concentration, and a round that runs without the owner in it. The same work that raises the headline number moves more of it to completion day.

It also tells you what not to bother arguing. A buyer will not remove deferred consideration because you have assured them the clients are loyal. They will reduce it because the evidence in front of them says the clients are contracted, audited and served by people who are staying.

The MechanicsWhat makes an earn-out achievable rather than theoretical

The metric decides almost everything. Retained contracted recurring revenue measured at an anniversary is the cleanest test in this trade: it is objective, it sits in a system both sides can read, and it measures the thing the buyer was actually worried about. An earn-out on post-completion EBITDA is far riskier for a seller, because the buyer controls the cost base and can allocate group overhead, insurance and management charges in ways nobody contemplated at signing.

Definitions then matter more than the percentage. What counts as a retained contract if the client reduces frequency rather than cancelling. What happens to an account lost because the buyer repriced it. Whether contracts won during the period count towards the target. Whether a client acquired by a group that already uses another provider is a loss or an exclusion. Every one of those has cost somebody real money in a real deal because it was left to be sorted out later.

Control during the period is the third piece. If your money depends on renewal, you need enough authority to influence renewal: continued involvement with the key accounts, a say in pricing decisions affecting them, and information rights so you can see the numbers being measured. A seller with an earn-out and no visibility is relying on goodwill, and goodwill is not a mechanism.

Keep the period short. Two years is common and one year is better, because the further out the measurement date sits, the more of the outcome is decided by decisions you do not make. A smaller sum over a shorter, clearly defined period is usually worth more than a larger one measured three years into somebody else's ownership.

The Tax PointThe part owners find out about too late

Business Asset Disposal Relief is 18% on qualifying gains up to a £1m lifetime limit, against a main capital gains rate of 24%, and the completion date governs which rate applies to the disposal. That much most owners know by the time they reach heads of terms.

What catches people is how contingent consideration is treated. Following the principle in Marren v Ingles, the right to receive an uncertain future sum is itself an asset acquired at completion, and it has to be valued and brought into the disposal at that point. In plain terms, tax can fall due on money that has not arrived and might never arrive, and if the earn-out underperforms the later adjustment is a separate matter rather than a simple refund.

None of that is a reason to refuse deferred consideration, and it is not advice on your position. It is a reason to have your accountant look at the structure before heads of terms are signed rather than after, because the shape of the consideration is much easier to negotiate while the buyer still wants the deal than once the lawyers have started drafting.

Tax can fall due on money that has not arrived and might never arrive.