Earn-out: how part of the deal price depends on what happens after closing

An earn-out is a deferred part of the deal price that the buyer pays the seller only if the company delivers pre-agreed results after closing. The fixed portion is paid immediately; the variable portion is paid at the end of a measurement period, under a formula tied to a financial or operational metric. The economic logic is always the same: the parties could not agree on what the future is worth, so they moved the argument from the negotiating room into the accounts and decided to pay for actual results rather than for a forecast.

What problem it solves

A valuation gap almost always comes from the forecast. The seller believes that next year's contract is signed and the revenue will arrive; the buyer sees the pipeline but does not see the cash. An earn-out turns this disagreement into a payment condition: if the forecast materialises, the seller receives a top-up payment, and if it does not, the buyer has not overpaid for something that never happened. Legally, the structure rests on freedom of contract (Article 421 of the Civil Code of the Russian Federation) and on the ability to make performance of an obligation conditional on the occurrence of circumstances, including those that depend on the actions of the parties (Article 327.1 of the Civil Code of the Russian Federation).

A separate motive is retaining the seller. If the founder stays on to run the asset, the earn-out works as a long-term incentive and stops them from letting go of the company the day after settlement. This is a useful side effect, but it is exactly what creates the main conflict: the seller starts managing the metric, not the business.

The calculation base shapes the seller's behaviour

The choice of metric is not a technical detail; it is a choice of what the seller will optimise.

Revenue is simple and harder to manipulate at the accounting level, but it encourages sales at any cost: discounts, instalment terms, poor counterparties. The buyer gets top-line growth and a damaged margin.

EBITDA is closer to the underlying economics, but it depends on how costs are distributed within the group, on the allocation of shared functions and on what the parties have agreed to treat as non-recurring. Any such item immediately becomes a subject of bargaining.

Net profit is the worst base for an earn-out: it is affected by the financing structure of the deal, the buyer's tax position and revaluations, that is, by decisions the seller does not control at all.

Operational and non-monetary metrics, such as customers connected, licences issued, a certification passed or a patent registered, often work better than financial ones. They are harder to fabricate, and they describe directly what the buyer paid for. Such things are easier to check against the public reporting of peer companies: the section with issuers' financial reports shows how comparable metrics behave over several periods.

Measurement period, threshold and cap

The longer the period, the closer the result is to the real dynamics of the business, and the more it is diluted by the buyer's decisions. The shorter the period, the higher the noise of an individual quarter. A workable compromise is a short horizon measured on a cumulative basis rather than on the last period alone.

The scale can be a threshold scale ("hit the target and get paid, miss it and get nothing") or a linear scale. A threshold scale is cheaper to administer and more dangerous: near the boundary the seller has an incentive to do anything at all just to get over it. A linear scale with a floor and a cap removes the cliff effect. The cap also serves the buyer: without it, a successful scenario can make the final deal price unjustifiable.

Covenants: the base needs protection from the buyer

After closing, the asset is run by the buyer, and the buyer is able to wipe out the metric without breaching a single letter of the agreement: by moving contracts to another legal entity of the group, changing transfer prices, cutting marketing or merging teams. This is why the agreement includes operating covenants for the measurement period: an obligation to run the business on a standalone basis, to keep the accounting policy unchanged, to obtain consent for reorganisations, and to limit intra-group extractions, including distributions of the acquired company's profit. For the seller this is not a formality but the only guarantee that the metric will reach the calculation stage at all.

Symmetrically, there must be a ban on the seller artificially inflating the base: related-party transactions, prepayments without delivery, shifting costs beyond the end of the period.

Calculation and dispute resolution

The procedure is worth setting out step by step. Step 1: the buyer prepares the calculation within an agreed deadline. Step 2: the seller gets access to the data and the books, otherwise the calculation cannot be verified. Step 3: objections are raised within a fixed deadline, specifying the disputed items. Step 4: positions that remain unresolved are referred to an independent expert whose determination the parties accept as binding. Without that final step the dispute goes to court, and the earn-out turns into a deferred conflict that would have been cheaper to replace with a discount to the price.

The public side of the deal

When the buyer is a public company, an investor can spot an earn-out through indirect signs. Contingent consideration is recognised as a liability at the acquisition date and is remeasured, which means that future remeasurements flow into profit and undermine its comparability. A deferred payment is also a claim on cash flow that competes with payouts to shareholders: check its due date against the dividend history and the corporate events calendar, and look for announcements about the price structure in the disclosure feed. The performance of the buyer's shares after the announcement is conveniently tracked in the Russian market stocks section.

Taxes: work from the current wording, not from memory

The tax outcome depends on what exactly is being sold (a participation interest or shares), who the seller is (an individual, a Russian company or a foreign company), how the deferred portion is documented and in which period it is recognised as income. These parameters change along with the wording of the Tax Code, and there is no universal answer here: the specific rates, holding periods and recognition rules have to be checked against the provision in force on the date of the deal. This article does not contain the factual data needed for a precise calculation, and replacing it with general statements would be worse than saying so plainly.

When an earn-out is unnecessary

If the valuation gap is small, it is cheaper to close it with a discount or with an unconditional deferred payment. If the seller leaves after closing and has no influence on the result, the condition loses its incentive value, and all that remains is the administration and the risk of a dispute. If the base cannot be measured on a standalone basis because the asset is integrated into the group straight away, there is nothing to calculate the earn-out on, and any formula will become a source of disagreement.

The terminology on deal price structures and related mechanisms can be checked in the platform's glossary.