An earn-out is a deferred payment arrangement built into a business sale where a portion of the purchase price is only paid if the business hits agreed performance targets after the sale completes. In Australia, earn-outs are common in SME transactions — particularly where a buyer and seller can’t agree on what a business is worth today. They’re a legitimate deal tool. They can also become a trap for sellers who don’t understand what they’re signing.
What Is an Earn-Out Arrangement?
An earn-out splits the sale price into two parts: an upfront amount paid on settlement, and a deferred amount paid later — contingent on the business reaching milestones you’ve both agreed on. Those milestones are typically financial: revenue, EBITDA, gross profit, or customer retention over the 12-36 months following the sale.
The logic from the buyer’s perspective is straightforward. Your business might be generating strong profit now, but much of that could be tied to you personally — your client relationships, your reputation, your hustle. A buyer paying full value upfront is carrying the risk that the business performs differently once you step back. The earn-out lets them say: “We’ll pay your full price, but only if the numbers prove out.”
From your side as the seller, you might view the earn-out as a chance to get paid for growth you believe is already locked in. I’ve seen deals where the seller was right about that. I’ve also seen deals where they were badly wrong.
The key distinction: an earn-out is only as good as the protections you negotiate into it.
How Are Earn-Outs Structured?
Earn-out structures vary, but in Australian SME deals you’ll typically see:
- Revenue-based targets — total sales turnover must reach a set dollar figure in year one and/or year two. Simple to measure, but doesn’t account for margin deterioration.
- EBITDA-based targets — earnings before interest, tax, depreciation, and amortisation. More meaningful than revenue, harder to manipulate, but vulnerable to the buyer’s cost decisions post-sale.
- Customer retention targets — a minimum percentage of existing clients must remain active. Common in professional services and subscription-based businesses.
- Hybrid targets — a combination of the above, with different earn-out tranches triggered at different thresholds.
The measurement period, the base financial statements used to calculate performance, and the accounting policies applied all need to be defined precisely. Vague definitions are where disputes start.
How Are Earn-Outs Taxed in Australia?
This is where a lot of sellers get surprised — ideally in a good way.
Under the ATO’s look-through earnout right (LTEOR) rules (introduced in 2016), earn-out payments are treated as additional proceeds from the sale of the original underlying assets, not as ordinary income. This is significant. It means each payment is a capital receipt that may attract the 50% CGT discount if you held the asset for more than 12 months, and potentially the small business CGT concessions depending on your structure.
The rules have specific requirements: the earn-out must relate to assets that were genuinely sold, the payment must be contingent on future events (not just deferred), and the arrangement must be documented correctly in the sale agreement. There’s also a five-year limit on LTEOR treatment — earn-out periods running longer than five years lose the CGT treatment.
Critically, you’ll need to revise your CGT calculations when each earn-out payment is received. Your tax returns for those years will need to be updated accordingly. This is not something to run through your accountant as an afterthought.
For more on how the CGT framework applies to your sale overall, see our guide on tax on selling a business in Australia.
When Earn-Outs Make Sense — and When They Don’t
A buyer told me last year about a trade sale where the seller had built a plumbing business to around $4 million revenue — solid EBITDA, long-standing commercial contracts. The buyer’s concern was that three of those contracts had been renewed personally by the outgoing owner, and they wanted proof the relationships transferred. An earn-out based on contract retention over 18 months made sense for both sides. The seller retained the work, guided the handover, hit the targets, and got paid. Clean outcome.
That’s the earn-out working as intended.
It stops working the moment the buyer has more control over the outcome than you do. If you’re exiting the business entirely on settlement, and the earn-out targets depend on decisions the new owner will make — pricing, staffing, marketing spend, product mix — you’re essentially betting on someone else’s management. That’s a different category of risk.
Accept an earn-out when:
- The targets are tied to factors you’ll continue to influence during the earn-out period
- The upfront payment is enough that you’d be comfortable if you received nothing more
- The performance metrics are simple, objective, and verifiable
- The earn-out period is short — 12 to 24 months is manageable; 36 months is the outer limit
Push back on an earn-out when:
- The deferred portion represents more than 30-40% of the total deal value
- You won’t have a meaningful operational role during the earn-out period
- The metrics are complex, subjective, or dependent on buyer behaviour
- The buyer can’t demonstrate the financial capacity to make deferred payments
Negotiating the Earn-Out: What Sellers Miss
Most sellers focus their negotiation on the headline earn-out number. The clauses that actually protect you are usually buried in the mechanics — and this is where accountants and lawyers who don’t do this regularly miss things (which is more than occasionally the case in mid-market deals).
Accounting policy protections. The buyer controls the books post-settlement. Without explicit provisions, they can change accounting policies — accelerate depreciation, shift expenses, change revenue recognition timing — in ways that reduce reported EBITDA. Your earn-out agreement should lock in the accounting policies used to calculate performance metrics.
Non-interference clauses. The buyer shouldn’t be able to merge your business into another entity, redirect customers, or fundamentally change the product offering during the earn-out period without your consent — or without triggering full payment of the deferred consideration.
Reporting and audit rights. You need regular (at minimum quarterly) financial reports during the earn-out period, and the right to audit the figures independently if you dispute them. These provisions are routinely omitted from draft agreements. Put them back in.
Acceleration provisions. If the buyer sells the business again before the earn-out period expires, what happens to your remaining payments? Standard position is immediate payment of the full outstanding amount. Make sure this is explicit.
Dispute resolution. Define in advance how earn-out disputes are resolved — independent accountant determination is the most common mechanism in Australian deals, and it’s faster and cheaper than litigation.
For how earn-out negotiations fit into the broader deal process, see our overview of the M&A process explained.
The Seller’s Role During the Earn-Out Period
If you agree to an earn-out, you’ll typically need to stay involved in the business for the earn-out period — often as a consultant, general manager, or non-executive director. This commitment should be reflected in your transition services agreement, separate from the earn-out mechanics.
The tension during this period is real: you’re working to hit targets that benefit you financially, but in a business you no longer own, under direction from a new owner who may have different ideas about how to run it. The best earn-out arrangements include a clear governance structure — who decides what, how conflicts are resolved, what the buyer can and can’t change unilaterally.
The worst ones don’t address this at all and rely on goodwill between the parties. Goodwill, ironically, is the one asset that doesn’t hold its value in a post-settlement dispute.
Earn-Outs and Business Structure
Whether you’re selling shares in a company or selling the assets of the business affects how the earn-out payments flow through and are taxed. Share sales and asset sales have different CGT implications generally — see our guide on asset sale vs share sale in Australia — and those differences carry through to the earn-out treatment.
Your corporate advisor or M&A lawyer should model the after-tax outcome of the full deal including earn-out scenarios before you agree to heads of terms. The headline earn-out number is much less important than what you’ll net after tax on each payment.
FAQ
What is an earn-out agreement when selling a business?
An earn-out is a clause in a business sale agreement where part of the purchase price is deferred and paid only if the business hits agreed performance targets after settlement — usually over one to three years. It bridges the gap when a buyer and seller disagree on what the business is worth.
How are earn-outs taxed in Australia?
Under the ATO’s look-through earnout right (LTEOR) rules, each earn-out payment is treated as proceeds from the original sale of the relevant asset — not ordinary income. CGT applies, and you may be eligible for the 50% discount and small business CGT concessions depending on your structure.
Should I accept an earn-out when selling my business?
Accept one if the targets are tied to factors you’ll genuinely influence, the upfront payment is meaningful, and the metrics are objective. Refuse one if the deferred portion is large, you’ll have no real control post-settlement, or the buyer’s track record of managing similar businesses is unclear.
What happens to an earn-out if the buyer mismanages the business?
This is the central risk. Strong earn-out clauses include accounting policy protections, non-interference provisions, reporting rights, and dispute resolution mechanisms to protect you if the buyer’s decisions tank the numbers.
How long does an earn-out period typically last in Australia?
Most Australian SME earn-outs run between 12 and 36 months. Shorter periods are usually inadequate to measure sustainable performance; longer periods increase dispute risk and make it harder to enforce seller protections.
If you’re negotiating a deal that includes an earn-out, or you’re just starting to think about a sale, talk to Miro Capital. We work with business owners across Australia on M&A transactions in the $1 million to $20 million range, and we’ve seen what separates earn-out arrangements that pay out from ones that don’t.