Earn-out and price supplement: when and how to use them?
Introduction
When selling a business, seller and buyer do not always agree on the price. The seller sees the growth potential and wants to benefit from it. The buyer prefers to pay based on actual results, not promises. This is where the earn-out, also called price supplement, comes in.
This mechanism allows part of the payment to be deferred and made conditional on the company's future performance. In practical terms: you receive part of the price at signing, then additional payments if certain objectives are achieved. The earn-out calculation can be based on turnover, EBITDA, or other measurable indicators.
The earn-out facilitates the transaction when the parties have different views of the value. It secures the buyer whilst allowing the seller to fully value their business. But beware: poorly structured, it can generate conflicts. This guide explains the earn-out mechanism, its advantages, its risks, and best practices for using it effectively.
📌 Summary (TL;DR)
The earn-out is a price supplement conditional on the company's future performance after the sale. It bridges a valuation gap between seller and buyer by deferring part of the payment. The calculation can be based on turnover, EBITDA or specific objectives. To succeed, the clause must define measurable indicators, a clear duration, and provide for a conflict resolution mechanism.
📚 Table of contents
What is an earn-out?
An earn-out is a conditional price supplement mechanism when selling a business. The principle: part of the sale price is paid after the transaction, based on the company's future performance.
In practical terms, the acquirer pays a base amount at signing, then a deferred payment if certain objectives are achieved. The typical duration of an earn-out clause varies between 1 and 3 years.
This mechanism is frequently used in Swiss SME transfers to secure the transition and align the interests of both parties.
Why use an earn-out?
The earn-out addresses several common situations in business transfers:
- Divergence on valuation between seller and acquirer
- Growing company with uncertain potential
- Need to retain the seller during the transition
- Sectors with high volatility or client dependency
This mechanism bridges the gap between the expectations of the seller (who values future potential) and the caution of the acquirer (who wants to pay for proven results).
Valuation gap between seller and buyer
Disagreement on price is the main reason for using an earn-out. The seller wants to value the growth potential and future opportunities. The acquirer prefers to pay based on concrete and verifiable results.
The earn-out resolves this impasse: the base price reflects the current situation, the supplement rewards future performance. Both parties thus share the risk and the opportunity.
To establish a solid basis for discussion, use our business valuation tool.
Transition and retention of the seller
The earn-out strongly motivates the seller to remain involved during the transition period. Their price supplement depends directly on the company's performance.
This involvement facilitates the transfer of knowledge, maintenance of client relationships and operational continuity. The seller has a direct financial interest in ensuring the success of the transition.
This is particularly relevant for businesses where the seller's personal relationship with clients or teams is decisive.
How to calculate an earn-out: practical examples
The calculation of an earn-out is based on measurable performance criteria. The most common: turnover, EBITDA, net profit, or specific objectives.
The important thing is to define a clear formula, verifiable and accepted by both parties. Here are three approaches with figures in a Swiss context.
Earn-out based on turnover
Example: SME sold for 1,000,000 CHF + earn-out of 10% of turnover exceeding 2,000,000 CHF over 2 years.
Favourable scenario: Turnover year 1 = 2,300,000 CHF, year 2 = 2,500,000 CHF. Earn-out = (300,000 + 500,000) × 10% = 80,000 CHF.
Unfavourable scenario: Turnover year 1 = 1,900,000 CHF, year 2 = 2,100,000 CHF. Earn-out = (0 + 100,000) × 10% = 10,000 CHF.
Simple to calculate, but may encourage prioritising volume at the expense of profitability.
Earn-out based on EBITDA or profit
Example: Company sold for 800,000 CHF + 30% of EBITDA exceeding 150,000 CHF over 3 years.
Scenario: EBITDA year 1 = 180,000 CHF, year 2 = 200,000 CHF, year 3 = 170,000 CHF. Earn-out = (30,000 + 50,000 + 20,000) × 30% = 30,000 CHF.
This criterion is often preferred to turnover: it reflects actual profitability and limits manipulation through volume increase without margin.
More representative of effective value creation.
Earn-out based on specific objectives
Some earn-outs are based on qualitative criteria:
- Signing of 3 major client contracts (50,000 CHF per contract)
- Retention of 90% of strategic clients (bonus of 100,000 CHF)
- Obtaining ISO certification (25,000 CHF)
These objectives suit specific situations, but have limitations: more difficult to measure objectively, risk of divergent interpretation, potential for conflict.
To be used in addition to financial criteria, never alone.
The key elements of an earn-out clause
A well-drafted earn-out clause avoids future conflicts. It must precisely define all the parameters of the mechanism.
Here are the essential components to include in the sale contract to secure the arrangement and protect the interests of both parties.
Duration and payment schedule
The typical duration of an earn-out varies between 1 and 3 years. Beyond that, uncertainties increase and the link with the seller's action weakens.
Define the frequency of payments: annual (more common), half-yearly or at the end of the total period. Specify the exact dates for closing accounts and payment.
A clear schedule avoids misunderstandings and facilitates financial planning for both parties.
Measurable performance indicators
The criteria for calculating the earn-out must be objective, verifiable and non-manipulable. Favour standard accounting data (turnover, EBITDA, net result).
Define precisely how each indicator is calculated: which charges to include, which adjustments to apply, which accounting standard to use.
Provide for verification by an independent accountant or fiduciary. Our network of partners can support you in this process.
Minimum thresholds and caps
Define a minimum amount (floor) below which no earn-out is paid, and a maximum (cap) to limit the acquirer's exposure.
Example: Earn-out of 20% of EBITDA between 200,000 and 400,000 CHF, capped at 150,000 CHF.
You can also provide intermediate tiers for more predictability. These limits reassure the acquirer about the final cost and guarantee the seller a significant supplement if the objectives are achieved.
Governance and control during the earn-out period
Specify the level of involvement of the seller: consultative function, operational position, simple right to information? Define their rights of access to financial data.
The acquirer must commit to managing the company according to the principle of going concern: no major strategic changes that would artificially compromise the earn-out objectives.
This clause protects the seller against manipulation whilst preserving the acquirer's freedom of management.
The risks and limitations of the earn-out
The earn-out mechanism has advantages, but also risks for both parties. It is important to know them in order to structure a balanced clause.
Here are the main points of attention for the seller and the acquirer.
Risks for the seller
The seller faces several uncertainties:
- Uncertain payment: the supplement depends on future performance beyond their total control
- Dependence on acquirer's decisions: investments, recruitment, commercial strategy
- Risk of manipulation: the acquirer can artificially increase charges to reduce EBITDA
- Tax complexity: taxation spread over several years
- Deferred liquidity: part of the price is not immediately available
Hence the importance of a precise clause and legal support.
Risks for the acquirer
The acquirer must also manage certain constraints:
- Uncertain final cost: the total price of the acquisition is not fixed in advance
- Management constraints: obligation to maintain a certain continuity so as not to compromise the earn-out
- Potential conflict: tension with the seller if objectives are not achieved
The acquirer must therefore balance their freedom of management with their contractual obligations linked to the earn-out.
Best practices for a successful earn-out
A well-structured earn-out minimises conflicts and facilitates the transition. Here are the recommendations for building a balanced and pragmatic mechanism.
Get support from experts
Drafting an earn-out clause requires legal and financial expertise. A lawyer specialising in company law secures the contractual wording.
An accountant or fiduciary defines the calculation criteria and verification procedures. These professionals anticipate areas of conflict and propose balanced solutions.
The Leez partner network brings together business transfer experts, available without obligation on your part.
Favour simplicity and transparency
A complex earn-out multiplies the risks of disagreement. Limit yourself to 1 or 2 key indicators, easy to calculate and verify.
Avoid convoluted mathematical formulae. Favour standard accounting data, already produced as part of day-to-day management.
Transparency is essential: both parties must understand exactly how the supplement will be calculated, without any possible ambiguity.
Provide for a conflict resolution mechanism
Despite all precautions, disagreements may arise over the interpretation of the earn-out clause. Include an arbitration or mediation clause in the contract.
Designate in advance an independent expert (fiduciary, auditor) responsible for verifying the accounts and deciding in case of dispute over the calculations.
Define a clear process: challenge period, expert procedures, allocation of costs. This anticipation preserves the relationship between the parties and accelerates resolution.
The earn-out is an effective structuring tool to facilitate a business transfer when seller and buyer do not agree on the valuation or when the seller remains involved in the transition. By linking part of the price to future performance, it reduces risks for the acquirer whilst offering the seller the opportunity to fully value their business.
However, an earn-out clause must be simple, measurable and framed. Performance indicators, duration, thresholds and governance must be defined precisely to avoid any conflict. Both parties benefit from being supported by legal and financial experts to secure the transaction.
If you are considering selling or acquiring a business, start by estimating its value free of charge or explore the opportunities available on Leez. You can also contact our network of expert partners to support you in structuring your transaction.
