An earn-out makes part of the purchase price dependent on the results the business achieves after completion. It works well when buyer and seller disagree about value, but it often leads to disputes, because the seller’s money depends on decisions taken by the buyer after the sale.
The seller is confident about the forecast, the buyer is not. Instead of arguing about the projection, they agree that the actual results will settle it. That is the strength of an earn-out: it closes transactions that would otherwise fail. It is also its weakness: the person who now runs the business largely controls the figure on which the seller is paid.
What must an earn-out clause define?
Four elements decide whether an earn-out works: the metric, the period, the formula and the accounting basis. If one of them is vague, a dispute about the payment is likely.
The metric can be revenue, gross margin, EBITDA or another figure, and each creates different incentives. Revenue is easy to measure, but also easy to inflate at the expense of margin. EBITDA is closer to the value of the business, but far more open to accounting influence.
The measurement period is usually one to three years. The formula sets how the payment is calculated, including any threshold below which nothing is paid and any cap. The accounting basis states which policies apply, whether and how they may change, and who prepares the figures.
How can the seller protect the payment?
The seller’s risk is that the buyer depresses the figure, deliberately or simply by running the business its own way. Protection comes from covenants, information rights and a fast dispute mechanism.
Ordinary decisions after completion can lower the result without any bad faith at all. Think of allocating group overheads to the acquired company, moving a customer to a sister entity, deferring revenue until after the earn-out period, or investing heavily in growth that reduces short-term profit.
The contractual protection follows from that list. Agree covenants on how the business will be run during the period: no change to accounting policies, arm’s length terms for group transactions, no transfer of customers or contracts out of the entity, and a defined level of continued investment.
Give the seller information rights, with periodic figures rather than a single statement at the end, and an audit right. And agree a dispute mechanism: an independent expert with a short timetable, rather than court proceedings two years later.
What does Dutch law add if the contract is silent?
Dutch law offers a backstop, but it is no substitute for careful drafting. The requirements of reasonableness and fairness (redelijkheid en billijkheid) apply to every agreement.
According to article 6:248 BW, an agreement has not only the legal effects the parties agreed, but also those that follow from the law, custom and reasonableness and fairness. A buyer who manipulates the outcome can therefore be held liable.
Where the earn-out is structured as a conditional payment, article 6:23 BW may also help the seller. If the party with an interest in the condition not being met has prevented it from being met, the condition counts as fulfilled, if reasonableness and fairness require this. The reverse rule applies to a party who brings about the condition in its own interest.
Relying on these open standards is expensive and uncertain. The court weighs all circumstances, and the outcome is hard to predict. Treat them as a safety net, not as a plan.
How can the buyer protect itself?
The buyer’s risk is the mirror image: a seller who stays on and manages towards the metric at the expense of the business. Examples are chasing revenue that will not repeat, or postponing necessary expenditure.
Where the seller remains involved, the covenants should run both ways. The earn-out should also be aligned with the metric the buyer actually cares about.
The buyer should also agree what happens if it sells the business on, or reorganises it, during the earn-out period. The usual solution is to accelerate payment on a defined basis, rather than leaving the clause to operate on an entity that no longer exists in the same form.
What are the practical drafting points?
Use a worked example, keep the period short and set a realistic threshold. Also check whether a simpler price mechanism gives the same result.
- Define the metric by reference to a worked example annexed to the agreement. A numerical example resolves more disputes than a paragraph of definitions.
- Keep the measurement period short.
- Set the threshold at a level that is realistically achievable. An earn-out that everyone privately expects to fail is simply a discount presented as a payment.
- Consider whether a simpler mechanism, such as a lower fixed price or deferred payment without conditions, would achieve the same commercial result without the risk.
ຄໍາຖາມທີ່ຖືກຖາມເລື້ອຍໆ
Is an earn-out a condition under Dutch law?
It can be. If the payment only becomes due when a target is met, the rules on conditional obligations in the Dutch Civil Code may apply, including article 6:23 BW.
Who decides if the parties disagree on the calculation?
That is up to the agreement. Many parties choose an independent expert whose decision is binding (bindend advies). Without such a clause, the dispute goes to court.
ໃນບົດສະຫຼຸບ
- An earn-out ties part of the price to results after completion and bridges a gap in valuation.
- Define the metric, period, formula and accounting basis precisely, preferably with a worked example.
- The seller needs covenants, information and audit rights, and a fast dispute mechanism.
- Articles 6:248 and 6:23 BW offer a backstop, but they are uncertain and costly to rely on.
- The buyer should agree two-way covenants and what happens on a sale or reorganisation.
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