Earn-outs and deferred consideration: what the deal is really worth

Two offers of £1.2 million can be worth wildly different amounts. The headline price is the least informative number in a deal — the structure decides how much of it you keep, when you get it, and whether you get it at all.

The building blocks

Completion cash. Paid on the day. Certain, and the only part you can bank.
Deferred consideration. A fixed sum paid on a fixed date, not conditional on performance. Risk is the buyer's solvency and willingness to pay, so security matters.
Loan notes. Deferred consideration in instrument form, sometimes interest-bearing, occasionally secured or guaranteed. Read the redemption and subordination terms.
Earn-out. Conditional on the business hitting targets after completion. The most valuable-looking and least certain element.
Retention or escrow. Held back against warranty claims or a completion accounts adjustment, released after a set period.
Rolled equity. The seller keeps a stake in the buyer's vehicle. A second investment decision dressed as consideration.

A worked comparison

Two offers on the same business, both headlined at £1.2m:

Offer A: £1,050,000 cash at completion, £150,000 retention released after 12 months.
Offer B: £700,000 cash, £150,000 deferred at 12 months, £350,000 earn-out on EBITDA over years two and three.

Risk-adjust and discount them and the picture changes. Offer A is worth roughly £1.19m in today's money at a modest discount rate with a high probability of the retention releasing. Offer B, with the earn-out probability-weighted at, say, 55% and discounted over three years, lands nearer £950,000 — and every pound of the difference depends on decisions the buyer will be making, not the seller.

The seller who takes Offer B has not been cheated. They have accepted about £240,000 of risk in exchange for a bigger headline. The problem is only ever that most sellers do this without anyone putting the two numbers side by side.

How to risk-adjust an offer yourself

Split the price into its components and note the payment date for each.
Assign a realistic probability to each contingent element, based on the target as written, not the target as described in conversation.
Discount each element back to today. A rate of around 8-15% is a reasonable range for SME counterparty and timing risk; unsecured deferred amounts from a small buyer belong at the top of it.
Deduct the tax on each element at the rate that will actually apply when it is received.
Compare the totals. Then ask what the cash-only price would need to be to match.

Earn-out drafting: where deals go wrong

An undefined measure. "EBITDA" alone is not a definition. Fix the accounting policies at completion and include a worked example calculation as a schedule.
Buyer control of the levers. Management charges, group recharges, integration costs, redirected leads and shared overheads can all reduce a target measure legitimately. Exclude them expressly.
All-or-nothing cliffs. Missing a target by 2% and losing 100% of the payment creates a fight. A sliding scale with a floor and a cap is fairer to both sides.
No information rights. The seller should receive monthly management accounts and have a right to inspect the calculation, with an independent expert as tie-breaker.
No acceleration on change of control. If the buyer sells or restructures during the earn-out period, the balance should fall due.
Constraints on the seller's ability to deliver. If the seller is expected to hit targets, they need the authority, budget and headcount to do it — written into the agreement, not assumed.
Set-off against warranty claims. Buyers often draft a right to set warranty claims off against the earn-out. Sellers should cap or resist this.

The buyer's side of the same question

Structure is not just seller protection. For a buyer, contingent consideration is the main tool for pricing uncertainty — customer concentration, owner-dependence, a recent step-change in profit that may not repeat. But an earn-out that is too aggressive buys three years of an unhappy former owner still inside the business, and buyers routinely underestimate what a disputed calculation costs in management time and goodwill. If the gap can be closed with a modest price reduction and clean completion, it usually should be.

Buyers should also check that the earnings the structure is priced off will survive scrutiny — see SDE vs EBITDA and our buy-side valuation service.

Do this before heads of terms, not after

Every point above is far easier to change before signing. Once heads of terms are signed and exclusivity has started, the structure is treated as settled and any reopening looks like bad faith. A deal agreed sense check values the structure properly, sets out the present-day worth of what you have been offered, and lists the terms worth pushing back on — a written report in 3 working days for £495, before the diligence and legal spend starts. Related: heads of terms vs LOI.

Common questions

What is an earn-out?

Part of the purchase price that is only paid if the business hits agreed performance targets after completion, usually measured over one to three years on revenue, gross profit or EBITDA. It bridges a gap between what a seller believes the business will do and what a buyer will pay for on day one.

What percentage of a UK SME sale price is typically deferred?

On owner-managed UK SME deals it is common to see roughly 60-80% paid in cash at completion, with the balance in deferred consideration, loan notes or an earn-out over one to three years. Where earnings are concentrated in a few customers or heavily owner-dependent, the contingent share is usually larger.

How do you value an earn-out?

Risk-adjust and discount it. Estimate the probability of each target being met on the definition actually written into the agreement, apply a discount rate reflecting the delay and the counterparty risk, and treat any element the buyer controls as materially less certain. A £400,000 earn-out payable in year three, tied to a profit measure the buyer influences, may be worth well under half its face value.

Are earn-outs risky for sellers?

They carry real risk, because the seller no longer controls the business generating the target. The main protections are: an objective measure defined in writing with a worked example, agreed accounting policies fixed at completion, restrictions on the buyer moving costs or revenue between entities, a sliding scale rather than an all-or-nothing cliff, information rights, and a right to accelerate payment on a change of control.

Should the earn-out be measured on revenue or EBITDA?

Revenue is simpler and much harder for a buyer to manipulate, so sellers usually prefer it; buyers resist because profitable revenue is the point. EBITDA aligns incentives better but exposes the seller to the buyer's cost allocations, management charges and integration decisions. Whichever is used, the definition, the accounting policies and the exclusions must be written out in full.

Is deferred consideration taxed differently in the UK?

Tax treatment depends on whether the deferred amount is ascertainable at completion, and on whether it is paid in cash or in shares or loan notes. This affects both timing of CGT and Business Asset Disposal Relief eligibility, so the structure should be reviewed with a tax adviser before heads of terms are signed rather than afterwards.

The Business Valuers provides independent, fixed-fee valuations and deal reviews for UK SMEs. This article is general commentary, not legal or tax advice, and figures are illustrative rather than a valuation of any specific business.