Term used to describe payment after the sale of a business or other income-generating asset (e.g., an assignment of IP) of a proportion of profits or turnover (gross or net earnings) or a fixed sum to be derived from the post-sale profits or turnover. Usually the vendor retains title or a recorded security interest until the earn-out is complete. From the perspective of a purchaser, the use of an earn-out clause: (a) allows it to avoid paying the full capital sum up-front; (b) encourages the vendor to ensure that the business is transferred in the most optimal way, preserving customer goodwill; and (c) can protect against overvaluation of the business, since part of the price depends on the ability of the business to generate the earn-out.
From the perspective of the vendor, an earn-out clause means that payment is not made upfront so there is no clean break and usually at least part of the purchase price is uncertain; however, it can maximize price, and where a business has substantial growth prospects, allows the vendor to retain some of the post-sale upside. The main difficulty with earn-out clauses lies in specifying what specific actions, activities or events, as well as their timing, entitle the seller to the post-sale payments and quantifying the amount of such payments. In addition, in some instances the buyer may find the seller’s ongoing assistance unnecessary to realize value and seek to frustrate the seller’s efforts to fulfill its obligations under the earn-out provision in an effort to avoid payment.