What an earn-out is, and why the headline number is not the sale price
An earn-out is a business sale structure where part of the price is deferred and made contingent on the business hitting agreed performance targets after completion, rather than paid in cash on settlement. A typical structure splits the price into two tranches: for example, a buyer offering $2m for a business might pay $1.2m at completion, with the remaining $800k contingent on the business hitting agreed targets over the following two years. The seller's advisers often describe this as a $2m sale. It is not. It is a $1.2m sale with a right to receive up to a further $800k, subject to conditions the seller frequently no longer controls. Treating the headline figure as the transaction value — for negotiation purposes, for retirement planning, for comparing competing offers — is the single most common way sellers misprice an earn-out deal. The correct starting position is to separate the certain component from the contingent component and value each on its own terms, not to add them together as if they carry the same risk. Australian earn-out periods commonly run from one to three years, though they can extend longer; periods beyond five years lose access to the CGT look-through treatment described below. An earn-out is also not the same structure as vendor finance, even though both defer part of the sale price: vendor finance is a fixed, seller-funded loan the buyer repays on agreed terms regardless of how the business performs afterward, while an earn-out is genuinely contingent, so the seller is paid more, less, or sometimes nothing, depending on results.
Risk-adjusting the contingent component
An $800k earn-out with a 90% chance of being paid in full is worth something close to $720k in present-value terms, before discounting for the time delay. An $800k earn-out with a 40% chance of being paid in full — because the metric is aggressive, the buyer controls the inputs, or the underlying market is volatile — is worth closer to $320k, and arguably less once the buyer's incentive to under-deliver against the target is factored in. The gap between those two scenarios is not a rounding error; it can be the difference between a good deal and a bad one dressed up with a large number on the front page. A supportable view of what an earn-out is worth requires: probability-weighting each payment tranche against a realistic (not the buyer's optimistic, not the seller's hopeful) forecast of the underlying metric; discounting the weighted expected value back to present terms to reflect the delay and the risk of dispute or non-payment; and stress-testing the forecast against what happens if the seller has genuinely lost operational control, which in an earn-out they usually have. This is a valuation exercise, not a negotiation tactic — the same probability-weighting and discounting discipline a valuer applies to any contingent consideration or deferred payment right, documented rather than asserted, consistent with the market value basis in IVS 104 and the reporting standard in APES 225 Valuation Services.
Metric design determines whether the earn-out is fair or is a trap
The metric the earn-out is measured against does more to determine the real value of the deal than the headline percentage split. Revenue targets are the easiest to measure and hardest to game from the buyer's side, but they say nothing about profitability — a buyer can hit a revenue target by discounting margin to zero and the seller is paid on a number that generated no actual profit. EBITDA targets link the payment to profitability, which is usually what the seller actually cares about, but EBITDA is also the easiest metric for a buyer to manage downward: reallocating central overheads into the acquired entity, changing supplier terms, deferring revenue recognition, or restructuring management reporting all move EBITDA without changing the underlying business the seller sold. Customer-retention or contract-renewal targets are common in professional-services and subscription businesses and are harder to directly manipulate, but they still depend on how the buyer treats the client base post-completion — service levels, pricing changes, and cross-sell decisions are all buyer-controlled variables that affect a metric the seller is paid against. There is no metric immune to gaming. The question for the seller is which metric is measured against terms fixed at completion, reported using an accounting policy the seller has visibility over, and least exposed to decisions the buyer alone makes after settlement.
The protections that make an earn-out defensible
An earn-out without protections is a bet on the buyer's good faith. The protections that experienced sellers and their lawyers negotiate address the specific ways buyers erode earn-out value: control covenants that require the business to be run substantially as it was pre-sale — no material change in pricing, staffing, product mix, or customer terms without the seller's consent during the earn-out period; an accounting-policy lock that fixes the accounting standards, cost allocation methodology and definitions used to calculate the target metric at completion, so the buyer cannot change how overheads are allocated or revenue is recognised partway through the earn-out period; audit and information rights giving the seller (or their accountant) access to the management accounts and the right to query the calculation; a dispute-resolution mechanism — typically referral to an independent expert — that sits outside the buyer's own finance function; and in some structures, an acceleration clause that crystallises the full earn-out immediately if the buyer sells the business, terminates the seller's employment without cause, or materially breaches the control covenants during the earn-out period. None of these protections guarantee payment. They shift the burden from the seller having to prove bad faith after the fact to the buyer having to justify departures from an agreed baseline. That shift is where most of the practical value sits.
The CGT look-through treatment — and its limits
Where an earn-out arrangement meets the conditions in Subdivision 118-I of the ITAA 1997 (the look-through earnout right rules, applying to rights created on or after 24 April 2015), the capital gain or loss on the earn-out right itself is disregarded, and each earn-out payment received is instead treated as additional capital proceeds for the original CGT event in the year it is received or accrued. This avoids the seller being taxed twice — once on an estimated value of the earn-out right at the time of sale, and again on the actual payments as they arrive. To qualify as a look-through earnout right, the arrangement generally needs to meet several conditions concurrently: the right is to financial benefits that are not reasonably ascertainable at the time the right is created; the right arises under an arrangement for the disposal of a CGT asset that was an active asset just before the disposal; all financial benefits under the right must be capable of being provided within a period ending no later than five years after the end of the income year in which the CGT event happened; and the financial benefits must be contingent on the future economic performance of the asset or a related business. This is a summary of the general framework, not tax advice — whether a specific earn-out structure satisfies every condition (including the 'not reasonably ascertainable' test, which the ATO has scrutinised closely) is a question for the seller's tax adviser, tested against the actual sale agreement. Prismi prepares independent valuations only; we are not a registered tax agent and do not provide tax advice. Where the look-through conditions are not met — most commonly because the earn-out period exceeds five years, or the payment is not genuinely contingent on performance — the earn-out right itself may need to be valued and taxed as separate capital proceeds at the time of sale, consistent with the ATO's market valuation for tax purposes guidance and the market value basis in IVS 104. That is a discrete, single-asset valuation question — closer in scope to Prismi's Essential tier (from $1,495 + GST, single methodology, 10–14 business days) than to a full business valuation — and it is precisely the kind of question that benefits from being resolved before the sale agreement is signed, not after.
When to refuse the earn-out and price the certainty instead
An earn-out is not always the wrong structure — it can genuinely bridge a valuation gap where the buyer and seller have a legitimate difference of view about forward performance, and it can let a seller participate in growth they helped create. But it is the wrong structure more often than deal momentum suggests, and there are specific circumstances where refusing it and negotiating for a lower certain price is the more defensible position: where the seller will have no operational control or influence over the business during the earn-out period; where the buyer's own financial position is uncertain enough that a two-year promise to pay carries real counterparty risk; where the metric on offer cannot be protected by any accounting-policy lock because the buyer intends to fully integrate the business into an existing operation; where the seller needs certainty of proceeds for retirement funding, debt repayment or a subsequent purchase and cannot afford to plan around a contingent number; or where the gap between the certain price and the earn-out-inclusive headline price is large enough that the probability-weighted value of the contingent component, once properly discounted, does not meaningfully exceed what a straight cash offer at a lower headline would deliver. In each of these cases, the discipline is the same one we apply to any valuation: work out what the earn-out component is actually worth on a risk-adjusted basis, compare it honestly to the certain alternative, and let that comparison — not the size of the number on the front page of the offer — drive the decision.