Earnouts: What Every Australian Business Seller Needs to Know

A buyer offers you $3.5M for your business: $2.2M upfront, and $1.3M over two years if EBITDA targets are hit. It sounds reasonable. The deferred component bridges the valuation gap, and it aligns your interests as you hand over the business.

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 bridge valuation gaps. If the seller believes future performance will be strong and the buyer isn't sure, an earnout lets both parties take a position: the buyer pays less upfront, and the seller earns more if they're right about the future.

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, 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 number. Missing it by 5% means the earnout clause triggers at a reduced rate or not at all.

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.

How to negotiate a better earnout

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 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.