How earn-outs work when you sell your business and where sellers get caught out

An earn-out is part of your sale price that you only receive if the business hits agreed targets after completion, usually measured over one to three years. It bridges a gap between what you think the business is worth and what a buyer is willing to pay upfront. The mechanics look straightforward on paper. In practice, sellers get caught out in three places: losing control of the business the earn-out depends on, definitions in the sale agreement that are looser than they seem, and a capital gains tax bill that can fall due before any of the earn-out money actually arrives.

Why earn-outs exist in the first place

A buyer offers an earn-out when they are not fully convinced by your numbers, when future growth depends on momentum, key staff or client relationships that only prove themselves after completion, or when you are staying on to run the business through a transition period. Rather than walking away from the deal or forcing you to accept a lower price today, the buyer agrees to pay more later if the business actually delivers.

For you as the seller, it can unlock a higher total price than a straight cash sale, but it also means part of your outcome now depends on decisions someone else is making about a business you no longer control.

How the numbers actually get calculated

Most earn-outs are tied to revenue, gross profit or EBITDA over the earn-out period, checked against a target agreed at completion. Revenue is the simplest to measure and usually the hardest to dispute, but it says nothing about profitability, and a buyer can grow revenue in ways that damage margin. EBITDA is closer to what actually matters commercially, but it depends heavily on accounting policy: how overheads are allocated, how one-off costs are treated, and whether the buyer’s group charges the acquired business for shared services it did not previously pay for. This is exactly where disputes start.

The sale and purchase agreement should set out an accounting hierarchy: specific adjustments agreed between the parties first, then the accounting policies used in your historic accounts, then UK GAAP or IFRS as a fallback. If that hierarchy is missing or vague, the buyer’s own accounting choices tend to fill the gap, and those choices rarely favour the seller.

The tax trap most sellers do not see coming

Here is the part that catches out even experienced sellers. If your earn-out amount cannot be calculated at the date of sale, HMRC treats it as unascertainable deferred consideration. The right to receive it is a separate asset for capital gains tax purposes, a principle established in Marren v Ingles. Your original disposal is taxed on the cash you receive plus the estimated market value of that right at completion, whether or not the earn-out is ever actually paid.

Business Asset Disposal Relief can apply only to that initial estimated value if the usual conditions are met. HMRC’s own internal guidance is clear that if the earn-out later pays out more than the original estimate, the extra gain does not qualify for BADR or another relief that applied to the original sale. If it pays out less, a loss may arise on the later disposal of the earn-out right, and in some cases it can be carried back against the gain on the original disposal, but this depends on the statutory conditions and timing.

The practical effect is a cash flow trap. You can owe capital gains tax on an earn-out right that later turns out to be worth less, or that the buyer never pays at all, with only a delayed route to relief. This is one reason it is worth reviewing your management accounts and expected sale structure well before you sign anything, rather than after the SPA is already agreed.

Losing control is the biggest practical risk

Once the deal completes, the buyer usually runs the business. They can restructure teams, cut costs, redirect resources to other parts of their group, or absorb your business into an existing division, all of which can suppress exactly the numbers your earn-out depends on without anyone acting in bad faith.

If you are staying on as part of the team, push for a genuine say in how the business is run during the earn-out period, ideally a board seat or clear operational protections. The SPA should say that the buyer will run the business in the ordinary course and will not take deliberate steps to depress the earn-out metric. Without that, you are taking financial risk on a business you no longer control, which is very different from the position you were in as owner.

Good leaver, bad leaver, and set-off

If you are expected to stay on, the agreement will usually include leaver provisions setting out what happens to your earn-out if you leave, whether by resignation, dismissal or otherwise, before the period ends. A badly drafted bad leaver clause can strip most of your earn-out for reasons only loosely connected to performance, so negotiate these definitions as carefully as the financial targets themselves.

Buyers will also often want the right to set off warranty or indemnity claims against earn-out payments. That creates an obvious risk if a claim is raised just before a payment falls due. A cap on set-off, or a requirement that disputed claims are resolved before amounts are withheld, is worth pushing for at the negotiation stage rather than after a dispute has already started.

What happens if the buyer cannot pay

An earn-out is a contractual promise, not a guaranteed payment, and it is only as good as the buyer’s ability to pay it when it falls due. If the buyer runs into financial distress during the earn-out period, you may become an unsecured creditor for whatever remains outstanding, with no special priority over anyone else the buyer owes money to.

Understanding what happens to creditors during insolvency matters here, because an earn-out claim sits well down the queue if the buyer ends up in administration or liquidation. Where the buyer group looks financially stretched at the point of sale, weigh that risk against the headline price and consider protections such as a parent company guarantee where the buying entity is a thinly capitalised subsidiary.

Practical protections worth negotiating

A few things consistently separate earn-outs that pay out cleanly from the ones that end in dispute. Get the accounting policies and metric definitions specified precisely in the SPA rather than left to be agreed later. Negotiate an expert determination clause for disputes over the calculation, since it is usually faster and cheaper than litigation. Push for visibility during the earn-out period through regular management accounts and audit rights over the calculation.

If a lender or the buyer’s own board wants assurance over the figures, an external audit of the earn-out accounts gives both sides a more defensible number than an internal calculation alone. Where a dispute arises over whether the numbers were manipulated, forensic accounting is the right tool to establish what actually happened, rather than relying on either side’s own version of events. And get proper advice on the CGT treatment before you sign, not after, since the tax position is largely fixed by how the deal is structured at completion.

If the buyer or the deal crosses into Ireland

If you are selling to a buyer based in Ireland, or your business itself trades across the UK and Ireland, the earn-out mechanics described here are UK specific. Irish capital gains tax treats deferred and contingent consideration under its own rules, and the reporting, valuation and relief position should not be assumed to mirror the UK position automatically. Getting this wrong is a common gap in cross-border deals, particularly where sellers assume UK tax planning carries across the border.

Our cross-border accounting and tax team works through both sides of a deal like this rather than treating it as a single jurisdiction problem, which matters when a business has been set up to operate in both the UK and Ireland from the outset.

Frequently asked questions

Is an earn-out taxed as income or as a capital gain?

Usually capital gains tax, provided it is genuine deferred consideration for the shares or business asset rather than disguised employment income for continuing to work in the business. HMRC will look closely at earn-outs that look more like a retention bonus than sale proceeds.

Can I negotiate to avoid an earn-out altogether?

Sometimes, particularly if you can close the valuation gap another way, such as accepting a lower headline price, agreeing fixed deferred consideration, or offering warranties that reduce the buyer’s risk. In practice, for many deals in the small and mid-market, some form of earn-out can be difficult to avoid entirely.

What happens if the earn-out target is missed by a small margin?

This depends entirely on how the SPA is drafted. Some agreements include a sliding scale so a near miss still pays out partially, while others are all or nothing at a single threshold. This should be checked carefully before you sign.

Getting the structure right before you sign

Most earn-out disputes trace back to gaps in the original agreement rather than bad faith after completion, and the tax position is largely locked in by how the deal is structured before you sign anything. If you are preparing your business for sale and expect an earn-out to be part of the conversation, get the accounting definitions, control provisions and tax treatment reviewed properly rather than leaving it to the due diligence stage. SCC Chartered Accountants works with sellers through the whole process, from structuring the deal to modelling what different earn-out outcomes actually mean for your after-tax position, so you go into negotiations knowing exactly what you are agreeing to.