- · Earn-outs are variable purchase price components that defer a portion of consideration until the business meets agreed performance targets, typically over a one-to-three-year horizon.
- · They serve as risk-sharing and alignment tools, offering buyers partial protection against valuation uncertainty and giving sellers a path to a higher total price.
- · Precise contractual drafting of metrics, calculation rules, and dispute mechanisms is the determinant of whether an earn-out delivers its intended value or generates post-closing litigation.
- · Swiss-domiciled individual sellers who remain active in the business after closing face a material risk of earn-out proceeds being requalified as salary income for tax and pension purposes.
Valuation gaps are a structural feature of private M&A. A seller who has built a business over two decades holds one view of its forward trajectory; a buyer performing financial due diligence holds another. Forcing a single fixed number onto both parties often produces an impasse. The earn-out mechanism offers a structurally different path: defer the contested portion of the price, tie it to measurable outcomes, and let the business itself arbitrate the disagreement.
As the Swiss M&A practice note from Lexology describes, earn-outs are "particularly useful if, despite extensive financial due diligence, different price expectations remain between the seller and the buyer." The mechanism transforms a binary negotiation into a forward-looking arrangement grounded in actual performance. That is its commercial logic.
An earn-out is a variable purchase price component made conditional upon the achievement of pre-agreed performance measures during a defined period following closing. According to Lexology's analysis of Swiss M&A pricing, the earn-out period is typically one to three years, and earn-out payments are ordinarily subject to a cap. Settlement can occur in cash, in shares of the acquiring entity, or in shares of the target company itself.
The earn-out serves two distinct commercial functions simultaneously. For the buyer, it reduces the risk and uncertainty inherent in any valuation exercise and allows partial financing of the purchase price through the future profits of the acquired business. For the seller, it creates a pathway to a total consideration that exceeds what the buyer would, or could, commit to upfront — provided the business meets its targets. As Swiss Contract Law observes, earn-outs are "pricing mechanisms that are generally beneficial to both parties."
Earn-outs appear most frequently in smaller transactions and are used less commonly in medium-sized and large M&A deals, according to Lexology.
The selection of performance metrics is one of the most consequential drafting decisions in an earn-out agreement. Parties have broad freedom to define the indicators, ranging from purely financial ratios to operational or regulatory milestones.
Financial indicators dominate conventional transactions. As MME Legal notes, "EBITDA or EBIT are often used in conventional transactions because of their high significance," with both reflecting "economic earning power at the operating level." Revenue or turnover is acknowledged as the most straightforward metric to calculate, though it captures top-line activity without reflecting cost discipline or profitability. Non-financial indicators — such as product development milestones, customer acquisition numbers, regulatory approvals, or order volumes — are also used, particularly in early-stage or technology-driven businesses where earnings figures may be less meaningful in the near term.
The practical implication is that the choice of metric shapes the entire dynamic of the post-closing period. A revenue-based earn-out creates different management incentives than an EBITDA-based one. Advisors and sellers should model the implications of each metric against the anticipated business plan before agreeing to terms.
Swiss law does not prescribe a mandatory earn-out structure, but it does impose consequences on agreements that leave material terms undefined. A 2021 decision by the Swiss Federal Supreme Court, discussed in detail by Swiss Contract Law, held that "a variable purchase price component presupposes a limitation in time of the Earn-Out Period." In that case, the contract was silent on the duration of the earn-out period, and the court imposed a two-year term as a gap-filling measure, reasoning that the seller's influence over business outcomes diminishes over time and that a buyer would have no basis to share indefinitely the earnings attributable to its own management.
The lesson for practitioners is unambiguous: every material earn-out term must be specified in the agreement. This includes the performance indicators themselves, the methodology for calculating them, the accounting principles to be applied, each party's control rights and disclosure obligations during the earn-out period, and the mechanism for resolving disputes. Silence on any of these points creates exposure to court interpretation, which may not reflect either party's original intent.
The earn-out period introduces an inherent tension: the buyer controls day-to-day management of the business while the seller retains a financial interest in its measured performance. This structure creates the conditions under which the buyer could, intentionally or otherwise, take actions that suppress the metrics on which earn-out payments depend.
Lexology is direct on this point: "Earn-out clauses may be subject to manipulation." Accordingly, well-drafted agreements should restrict the target company from undertaking actions with a potentially manipulative effect on the agreed indicators. These restrictions typically address mergers, demergers, asset sales, dividend distributions, and related-party transactions conducted on non-arm's-length terms. Sellers may also negotiate approval rights over material operational decisions that could affect earn-out calculations.
This is the part of earn-out drafting that sellers sometimes underestimate during the negotiating high of agreeing on a headline price. The protective provisions are, in many transactions, as commercially significant as the performance metrics themselves.
Swiss-domiciled individual sellers who hold shares as part of their private portfolio generally benefit from capital gains tax exemption on the sale of those shares. That exemption, however, carries a condition that is particularly relevant in earn-out scenarios.
If a seller continues to work for the target company during the earn-out period, Lexology notes that "there is a risk that all or part of the earn-out payment will be requalified as salary for tax and pensions purposes." The consequence is a materially higher tax burden on proceeds that the seller may have structured — and priced — as capital in nature. Advance tax review and careful structuring of the post-closing employment relationship are therefore prudent steps for any individual seller contemplating an earn-out arrangement.
Earn-outs carry costs alongside their structural benefits. The restrictions placed on the target company's operations during the earn-out period can delay integration and the realisation of synergies that motivated the buyer's acquisition. Management attention during the earn-out period may orient toward hitting short-term earn-out targets rather than toward the longer-term value creation priorities of the combined entity.
And when disputes arise, they can be both costly and protracted. As Lexology observes, "earn-out arrangements bear some risk of litigation" depending on the complexity of the individual arrangement. These are not reasons to avoid earn-outs; they are reasons to draft them with precision and to price the associated friction into the decision.
The earn-out's underlying logic — that two parties with different expectations about future value must find a mechanism to allocate that uncertainty fairly — resonates well beyond M&A boardrooms. The principle of shared risk and clear terms surfaces in everyday life, sometimes with fewer lawyers and considerably more awkwardness.
Consider this account circulating on social media:
A friend asked me to split a wedding gift with her. We chose a $180 cookware set and each sent $90. A week later, the store dropped the price to $120. Since the purchase was on her account, she requested a price adjustment and got $60 back on her card. I asked if she'd send me $30. She replied, 'But'§ @JustJumah8
The story ends, arrestingly, mid-sentence. One suspects the "but" was the beginning of an argument that a clearer upfront agreement might have prevented. In M&A, that "but" tends to arrive in the form of a dispute notice. The remedy, in both cases, is the same: agree on the terms before the price adjusts.
[@BskiMike22802](https://x.com/BskiMike22802/status/2105702363734405427) shared a link to related commentary on deal structuring dynamics.
[@signaloftheeye](https://x.com/signaloftheeye/status/2105755339412934755) added further perspective to the broader discussion on pricing mechanisms.
Earn-outs are a structurally sound response to a genuine market problem: the valuation gap that emerges when buyer and seller hold different but defensible views of a business's future. Their value lies in the alignment of interests they create and the additional consideration they can deliver to sellers whose businesses perform as anticipated.
That value is, however, entirely contingent on the quality of the underlying agreement. Performance metrics, calculation methodologies, accounting standards, operational restrictions, and dispute resolution procedures all require precise definition at the outset. Swiss courts have demonstrated a willingness to fill contractual gaps — but on terms that may serve neither party's original intent.
Sellers are well advised to approach earn-out negotiations with the same rigour they apply to the fixed portion of the purchase price. The total consideration depends on both, and the variable portion carries the greater drafting burden.
This article is a market observation prepared for informational purposes. It does not constitute legal, tax, or financial advice. Parties considering earn-out arrangements should seek qualified legal and tax counsel appropriate to their specific circumstances.
