When a company is sold, the sale price is not always definitively fixed at the time of signing. In many mergers and acquisitions (M&A) transactions, part of the price depends on the company’s future performance. This mechanism is known as an Earn-out, or contingent price adjustment.
However, a key question quickly arises: who really controls the company during the Earn-out period? The buyer or the seller?
This question is crucial because it can determine whether the conditions required to trigger the additional payment will actually be met.
In this article, we will explain how the Earn-out mechanism works, why it is used, and how governance can be organized to avoid conflicts.
Why Do Buyers Use an Earn-out?
When an acquirer purchases a company, they are not only buying its current situation. In reality, they are primarily buying its future growth potential.
The price offered therefore relies on several factors:
• the continuity of operations
• the resilience of the business model
• the company’s ability to generate growth
• future profitability
However, the buyer does not always know the company as well as the seller. They rely on information gathered during Due Diligence, but they have not experienced the business from the inside. As a result, buyers often adopt a cautious approach when assessing growth potential.
Information Asymmetry Between Buyer and Seller
In most transactions, the seller has a more optimistic view of the company. They know the teams, the customers, and the development opportunities. They are also more confident in managing risks.
This situation creates what M&A specialists refer to as information asymmetry.
In practical terms:
• the buyer remains cautious
• the seller believes more strongly in the company’s potential
This difference in perception often leads to a Valuation gap. The seller believes the company is worth more, while the buyer seeks to limit their risk.
Earn-out: A Mechanism to Bridge the Gap
To resolve this disagreement, transactions frequently use a mechanism known as an Earn-out.
The principle is simple. Part of the purchase price is paid immediately, while another portion is paid later if certain targets are achieved.
These targets may include, for example:
• a revenue threshold
• operating profit (EBITDA)
• a number of new customers
• or other performance indicators
In this way, both parties reach a compromise.
If future performance confirms the seller’s expectations, they receive an additional payment. Conversely, if the expected growth does not materialize, the buyer does not pay more.
According to several studies on business transactions — including analyses published by Harvard Business Review on M&A deals — earn-outs are particularly common in high-growth sectors or innovative companies.
A Positive Signal for Banks and Investors
A well-structured Earn-out can also reassure financial partners. Banks often view it as a signal of the seller’s confidence in the company’s future performance. It indicates that the former owner genuinely believes in the potential they presented.
This confidence can facilitate:
• acquisition financing
• obtaining a bank loan
• negotiating financing terms
For this reason, some sellers voluntarily accept an Earn-out to help ensure that the transaction can be completed.
But a Key Question Remains: Who Runs the Company?
However, the Earn-out mechanism quickly introduces a challenge. If part of the price depends on future performance, the management of the company becomes a critical issue.
The seller may fear that the buyer will make decisions that reduce performance.
For example:
• changing the commercial strategy
• modifying the internal organization
• reducing certain investments
• increasing certain expenses
These decisions may impact results and prevent the Earn-out targets from being achieved. In that case, the seller could lose part of the expected sale price.
The Buyer’s Perspective
From the buyer’s perspective, the situation is different.
After the acquisition, they generally want to take control of the company. This is logical: they become the new owner and want to implement their strategy.
They may wish to:
• restructure the company
• integrate certain functions into their group
• modify the commercial policy
• change the management team
However, these changes may conflict with the objectives defined in the Earn-out.
The Solution: Organizing Governance During the Earn-out Period
To avoid these tensions, it is essential to establish clear governance rules at the time the transaction is signed.
This is typically done through a transition agreement or a specific contract governing the Earn-out period.
This document generally defines:
• the responsibilities of the buyer and the seller
• the distribution of decision-making powers
• the rules for calculating financial indicators
• reporting procedures
The objective is simple: to prevent either party from artificially influencing the results.
Protecting the Calculation of Performance Metrics
Another essential aspect concerns how the performance indicators used to trigger the Earn-out payment are calculated.
The contract must clearly specify:
• the accounting standards used
• the calculation methods
• which elements are included or excluded from the results
For example, certain exceptional events or strategic decisions made by the buyer may be excluded from the calculation.
This helps protect the seller against unilateral decisions that could distort the results.
When the Seller Remains Involved in the Company
In many transactions, the seller continues to work within the company during the Earn-out period.
They may remain:
• CEO or executive
• consultant
• member of the board of directors
This arrangement often helps secure the expected performance. The seller retains some influence over management and can contribute to achieving the objectives.
Without this type of structure, the seller might prefer to maintain a stronger management role to protect their interests.
A Delicate but Essential Balance
In conclusion, the Earn-out is a very useful tool in business sale transactions. It helps reduce the Valuation gap between buyer and seller. It also aligns the interests of both parties with the company’s future performance.
However, it introduces a crucial issue: governance during the Earn-out period.
Without clear rules, conflicts may arise. This is why precise contract drafting and transparent management structures are essential.
When properly structured, the Earn-out becomes a win-win mechanism capable of securing the transaction and sharing future value creation.