You've spent 20-odd years building something real. A buyer comes along, offers $3.5M: $2.2M upfront, and $1.3M more over two years if the business hits profit targets — what buyers call EBITDA (earnings before interest, tax, depreciation and amortisation; basically, your operating profit before the accountant gets involved). It sounds fair. The deferred part closes the gap between what you think the business is worth and what the buyer is willing to pay today.
What happens in practice is often different. Targets get set based on what the business earned when you were running it. After the sale, costs change, strategy changes, integration happens, and suddenly the numbers aren't tracking. At twelve months, you're $80k short of the threshold. At month twenty-four, you're being told the earnout clause triggered at only 60 cents on the dollar. Learn more about hidden costs you need to account for.
This isn't uncommon. Global research consistently shows that a significant portion of earnouts are not paid in full. In the Australian SME market, the dynamic is particularly pronounced because most sellers don't have M&A lawyers at the table, and the people who drafted the earnout mechanism work for the buyer.
What an earnout actually is
An earnout is a deferred payment tied to post-settlement performance. The seller agrees to receive part of the purchase price later, contingent on the business hitting agreed financial targets after the sale. Learn more about working capital adjustments at settlement.
On paper, it's a tool to
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The problem is that once settlement occurs, the seller typically no longer controls the business, but the earnout calculation depends on the business's performance. That asymmetry is where things break down.
The five ways earnouts fail sellers
1. The performance metrics are defined by the buyer
Earnouts are typically calculated on EBITDA (that operating profit figure), revenue, or gross profit. Each of these can be influenced by decisions the new owner makes: changing accounting treatment, allocating shared service costs, delaying revenue recognition, accelerating expenses. None of these are illegal, they're just decisions a business owner makes. After the sale, that owner is the buyer.
2. The baseline is set at peak performance
Buyers often set earnout targets based on the last full year of trading, which, for most sellers, is a year they've been optimising for sale. You've cleaned up the accounts, managed discretionary spend, and possibly front-loaded revenue. The earnout target is set against that high-water mark, not a normalised (adjusted to reflect typical, sustainable performance) number. Missing it by 5% means the earnout clause triggers at a reduced rate or not at all.
Hypothetical example — how this plays out in practice:
Consider a family-owned commercial cleaning business in Brisbane turning over $2.8M. In the year before the sale, the owner ran lean — deferred two equipment purchases, collected outstanding invoices faster than usual, and held off on replacing two casual staff. EBITDA looked strong. The buyer set the earnout target based on that year. Post-settlement, the new owner needed to replace the equipment and staff. EBITDA dropped $120,000. The earnout clause triggered at 70 cents on the dollar — $364,000 instead of $520,000. Nobody did anything dishonest. The numbers just reflected different realities at different points in time.
3. Integration decisions affect performance
A trade buyer who integrates your business into their operation will allocate shared costs, centralise functions, and rationalise staff. Each of these decisions affects the P&L line that your earnout is measured against. Even with the best intentions, integration reduces your calculated EBITDA, and your earnout payment.
4. Dispute resolution is expensive
When an earnout dispute arises, your options are negotiation, expert determination, or litigation. All of these cost money. For a $300k deferred payment, spending $50k–$80k in legal fees to pursue a disputed earnout is often not economically rational, and buyers know this.
5. You're an employee, not an owner
Many earnout structures require the seller to stay on for the earnout period. You're now an employee, with an earnout tied to metrics you no longer control, working for the person who bought your business, in a role that's often less interesting than what you were doing. The tension this creates is real, and it frequently leads to early exits that void or reduce the earnout.
The honest reality: An earnout is a bet on your future performance, measured by the buyer's accountants, against targets set by the buyer's negotiators, in a business now run by the buyer. You need to price that risk appropriately, or negotiate it out.
How to negotiate a better earnout
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Get My Free Assessment →If a buyer insists on an earnout component, here's how to protect yourself:
Push upfront consideration as high as possible
The most reliable way to protect yourself from earnout failure is to take less of the total consideration as deferred. In our experience, anything above 25–30% of total consideration in earnout territory carries meaningful risk. If a buyer won't move the upfront component, that's a signal about their actual conviction in the business's future performance.
Define the metric precisely and protect it
EBITDA can be calculated many ways. The earnout agreement should define exactly: which revenue is included, how allocated costs are treated, whether integration costs are excluded, how shared services are charged. Get it defined before settlement, not in a dispute resolution process afterwards.
| Term to define | Why it matters |
|---|---|
| Cost allocation methodology | Shared overhead can be allocated to increase or decrease EBITDA |
| Integration costs exclusion | Merger costs shouldn't reduce your earnout |
| Revenue recognition policy | Delays in recognising revenue hit the EBITDA line |
| Capital investment requirements | Forced capex reduces free cash and EBITDA |
| Management decision carve-outs | Buyer decisions to change pricing, headcount, or strategy |
Include a floor and a partial payment structure
Binary earnouts, pay in full if target hit, zero if not, are the riskiest structure for sellers. Push for a sliding scale: 80% of target pays 80% of the earnout. This reduces the impact of small misses and gives you something even in underperformance scenarios.
Limit the transition period
If an earnout requires you to stay on, negotiate the shortest workable period, and define exactly what "staying on" means. Full-time employee? Advisory capacity? What decisions can you make, and which require the buyer's sign-off? The longer and more ambiguous the transition, the more exposure you carry.
Build in acceleration clauses
If the buyer sells the business, takes on significant debt, or makes decisions that materially change the business model during the earnout period, the deferred consideration should accelerate, i.e., become payable in full immediately. Without acceleration clauses, a buyer can sell on to a third party while your earnout is still outstanding.
When earnouts work
This isn't a case against earnouts, it's a case for negotiating them properly. In the right circumstances, an earnout can be a reasonable mechanism:
- When revenue is genuinely uncertain and both parties want to share the risk
- When the seller has significant control over the earnout metric post-settlement
- When the business is kept independent (not integrated) during the earnout period
- When the earnout is a small percentage of total consideration (under 20%)
- When the metric is simple, objective, and hard to manipulate (e.g., number of customers retained)
The key question to ask: "If I were the buyer, could I make decisions that reduced this earnout payment by $200k without breaching contract?" If the answer is yes, and it usually is, you need to either renegotiate the terms or restructure the consideration.
The bottom line
Earnouts are a legitimate deal tool. They're also the part of Australian business sale contracts that most sellers regret. The gap between the headline price and the cash you actually receive is largest when earnouts are involved.
The best time to protect yourself is before you sign, when you still have leverage. Once settlement occurs, you're in the buyer's world, and the earnout mechanism will be interpreted in the way that's most favourable to them.
If you're looking at a deal structure that includes a material earnout component, get the terms reviewed by someone who has seen these disputes from both sides before you agree to anything. Learn more about asset sale versus share sale structures.
Five things to do before accepting an earnout
- Ask what percentage of the total price is deferred. If more than 30% is in earnout territory, push hard to shift more upfront — or ask the buyer plainly why they're not confident enough to pay it now.
- Get the EBITDA definition in writing before you sign anything. Ask your accountant to walk through exactly which costs the buyer can allocate to your business after settlement, and how that affects the number.
- Check whether the earnout period requires you to stay on. If it does, get clear on your role, your authority, and what happens if the relationship breaks down — because it often does.
- Negotiate a sliding scale, not a cliff. A structure where hitting 80% of target pays 80% of the earnout is far safer than a binary arrangement where missing by $1 pays you nothing.
- Ask an accountant or commercial lawyer to review the earnout clause before settlement. The people who drafted it work for the buyer. The fee for an independent review is almost always worth it.
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