What are earn-outs and when are they used?

It would always be a vendor’s preference to receive the consideration in full on the sale of their company. In rare circumstances this can be achieved, require a proportion of deferred consideration.

This is especially true in the case of a management buyout (MBO) where funding for the deal is predominantly being raised secured on the company’s balance sheet and projected future cashflows.

Furthermore, funders gain comfort from the vendor’s financial endorsement of a management team.

A vendor may have reason to expect profits to grow after completion as a direct consequence of work carried out precompletion, for example a lucrative contract with a new customer may have been won shortly before the sale. An acquirer may only wish to pay consideration at completion based on historic performance to date, especially if a company’s profits have been flat for many years and are forecast to jump up.