In this guide
- An earn-out pays part of the price later, if the business meets agreed targets.
- Revenue is the easiest measure for a seller to verify; profit measures are easier for a buyer to influence.
- A sliding scale is usually fairer to the seller than a cliff where a near miss pays nothing.
- Protect the earn-out in the sale agreement: accounting rules, how the business is run, information and what happens on a resale.
- Value an offer with an earn-out on what you are likely to receive, and when, not on its headline.
Why buyers ask for earn-outs
An earn-out shifts some of the risk of the price from the buyer to you. Buyers ask for one when:
- the business depends heavily on you, your relationships or your licence
- profit has risen recently and the buyer is not yet sure it will last
- you and the buyer disagree on value, and the earn-out lets each test their view
- the buyer cannot fund the full price at completion
In return, a buyer will often agree a higher total price than it would pay all in cash on the day. Our guide to deal structures shows how an earn-out sits alongside cash at completion, deferred payments and retentions.
What an earn-out is measured on
| Measure | For the seller | Against the seller |
|---|---|---|
| Revenue | Simple to check, hard for the buyer to reduce through costs | Buyers worry it rewards unprofitable sales, so they may offer less |
| Gross profit | Reflects pricing and margins you can influence | Depends on how cost of sales is defined |
| EBITDA or net profit | What buyers value most, so they may pay more for it | Can be reduced by the buyer’s overheads, new hires or head-office charges |
| Non-financial milestones | Clear and objective, such as a contract renewal or a licence obtained | All or nothing, and may depend on third parties |
Whatever the measure, define it precisely in the sale agreement, including the accounting policies that apply and which costs may and may not be charged to the business.
How earn-outs are structured
- Period. Usually one to three years. Longer periods carry more risk for you, because more depends on decisions you do not make.
- Cliff or sliding scale. A cliff pays only if the target is met. A sliding scale pays a proportion between a floor and the target, so a near miss still pays something.
- Annual or cumulative. Annual targets pay sooner; a cumulative target lets a strong year make up for a weak one.
- Cap and floor. A cap limits the most you can earn; ask for upside above target too, if the buyer wants a cap.
- Catch-up. If year one misses but year two more than makes up for it, a catch-up clause pays the shortfall.
Protections to get in the sale agreement
The protections matter as much as the targets. Ask for:
- Accounting rules that match how the business was run before the sale, with a list of costs the buyer may not charge to it.
- Operating commitments: the business keeps trading in its current form, with a reasonable budget, staff and its name, and is not merged in a way that makes the result impossible to measure.
- Information rights: monthly management accounts during the earn-out, and access to check the calculation.
- Acceleration: the full earn-out becomes payable if the buyer sells the business, breaches these commitments or dismisses you without cause.
- Security for payment, such as a guarantee from the buyer’s parent company or money held in escrow.
- Disputes decided quickly by an independent accountant, rather than in court.
- No set-off of unrelated warranty claims against earn-out payments, unless agreed.
These terms are settled in the sale and purchase agreement, but the principles should be agreed in the letter of intent, before exclusivity.
How to value an offer with an earn-out
Compare offers on what you are likely to receive and when, not on the headline. An illustration with two offers for the same business:
| Offer A | Offer B | |
|---|---|---|
| Headline price | S$2,800,000 | S$3,200,000 |
| Cash at completion | S$2,500,000 | S$2,000,000 |
| Earn-out | Up to S$300,000 over one year, on revenue | Up to S$1,200,000 over three years, on EBITDA |
| Your realistic estimate of the earn-out paid | S$270,000 | S$600,000 |
| Likely total | S$2,770,000 | S$2,600,000 |
Offer B has the higher headline but pays less up front, depends on a measure the buyer controls and runs for three years. Unless you are confident in the targets and the protections, Offer A may well be worth more. Your estimate of what an earn-out will pay should reflect the measure, the period, how realistic the targets are and the protections you have.
How to need less of an earn-out
The size of an earn-out mostly reflects how much the business depends on you. Before you sell:
- Build a team that runs the business day to day, and step back from key relationships.
- Move customers onto contracts or regular arrangements that do not depend on you personally.
- Show three years of steady results, so recent growth looks durable.
- Agree a price based on a written valuation, so the gap an earn-out has to bridge is smaller.
Our exit-readiness check scores how dependent your business is on you, and our guide to preparing your business for sale covers the fixes.
Questions owners ask
What is a typical earn-out when selling a business in Singapore?
Earn-outs are most common where the business depends on the owner. In disclosed Singapore deals, the part of the price tied to future profit ranged from about 6% (How’s Catering, 2018) to about 77% (mm2 Asia’s 2016 term sheet). Businesses that run without the owner usually need a smaller earn-out, or none.
Should I accept an earn-out?
It can be worth it if the total price is higher, the measure is one you can verify, the period is short, and the sale agreement protects how the business is run and how the result is calculated. If most of the price depends on targets the buyer controls, push for more cash at completion instead.
What happens if the buyer changes the business during the earn-out?
That depends on the sale agreement. Without protection, changes such as new overheads, merging the business or moving customers can reduce the earn-out. Ask for operating commitments and for the earn-out to be paid in full if the buyer sells the business or breaches them.
Are earn-out payments taxed in Singapore?
Singapore does not have a capital gains tax, and earn-out payments that form part of the price for a business you have built are often treated as capital. The answer depends on the facts and how the payments are structured, so take tax advice before you agree the terms.