An earn-out is the part of a business sale price that depends on how the business performs after completion: the buyer pays, say, £6 million now and up to £4 million more over the next two or three years if profit targets are hit. It exists to bridge the oldest gap in M&A — the seller's confidence in the forecasts against the buyer's scepticism — by making the disputed slice of value prove itself. Around that simple idea sits some of the trickiest tax in deal-making, and sellers who discover it after signing routinely leave six figures on the table.
Here is how earn-outs work commercially, and the three tax traps that decide what sellers actually keep.
The commercial shape
Most earn-outs run one to three years and key off EBITDA (buyers' preference — it measures profit) or revenue (sellers' preference — it is harder for a buyer to depress with cost allocations). The drafting battleground is protection: an earn-out is a bet on numbers the buyer now controls, so well-advised sellers negotiate accounting policies frozen at completion, limits on management charges and cost-dumping, obligations to run the business consistently, and acceleration if the buyer sells on or shuts the division. An earn-out without conduct protections is not deferred consideration; it is a hope.
Trap one: you are taxed before you are paid
Where the future payments are unascertainable — dependent on results, capped or not — the tax analysis follows Marren v Ingles: the right to receive the earn-out is itself an asset, valued at completion and taxed as part of the initial disposal. Sell for £6 million plus an earn-out valued at £2.5 million and your year-one CGT computation is on £8.5 million — including tax on money you may never see. When each earn-out payment later arrives, it is a second disposal (of part of the right), taxed on the difference against that valuation; shortfalls generate capital losses that can usually be carried back against the original gain, but the cash-flow asymmetry is real and needs planning, not discovering.
Trap two: the relief mostly stops at completion
Business Asset Disposal Relief — 18% on the first £1 million of qualifying gains — applies to the disposal of the shares, which includes the valued earn-out right at completion. The later payments, though, are disposals of the right, not of shares, and get no BADR: they are taxed at the full 24%. Sellers structuring for relief therefore want the earn-out right valued realistically and supportably at completion — the counterintuitive result of Marren v Ingles is that a defensibly fuller day-one valuation puts more gain into the relieved computation (where the £1 million BADR capacity is not already exhausted by the upfront proceeds) — and specialist input on the numbers before the SPA is signed.
Where the earn-out right can only be satisfied in the buyer's shares or loan notes — no cash alternative — different machinery applies: security treatment under s138A TCGA then follows automatically, rolling the gain into the paper — with an irrevocable election available to opt out and crystallise now instead, typically to bank BADR at today's 18% rather than gamble on the rate and the paper both surviving. That election has a deadline (the first anniversary of the 31 January after the tax year) and, like everything here, works far better chosen than defaulted into.
Trap three: HMRC may call it salary
Most sellers stay on for the earn-out period — usually the buyer insists. That creates the risk HMRC recharacterises earn-out payments as employment income — income tax at up to 45% (rUK) plus NIC, against capital rates topping out at 24%, and its published factors are exactly what deal papers should be tested against: the earn-out should be stated as consideration for the shares and proportionate to the value sold; continuing sellers should draw a proper market salary for their ongoing work, so the earn-out is not disguised pay; payments should not be forfeited merely for leaving employment beyond reasonable value-protection; targets should be business performance, not personal performance; and non-employee sellers should participate on the same terms. An earn-out that walks and quacks like a retention bonus will be taxed like one.
Making an earn-out work for you
For sellers, the checklist runs: model the Marren v Ingles cash-flow (tax now, money later) and fund it; get the earn-out right professionally valued; test the employment-income factors against the actual drafting; decide the s138A position deliberately where paper is involved; and negotiate the conduct protections as hard as the headline price — an earn-out's value is set by the SPA's boilerplate, not its big number. For buyers, the mirror: an earn-out is cheap deal insurance, but sloppy interaction with management incentives and salaries creates PAYE risk that lands on the buyer's payroll.
And sometimes the right answer is no earn-out: a slightly lower fixed price, or deferred consideration with fixed instalments, beats a larger contingent number the seller cannot influence and the parties will litigate. The comparison deserves numbers, not instinct.
Acumon advises on both sides of earn-outs — structuring, valuation of the earn-out right, clearances and the elections — through our selling your business and tax planning teams, with valuations handling the day-one numbers the whole computation hangs on. The time to involve us is at heads of terms; by signing, most of the tax outcomes above are already decided.