Buyer Guide
Every deal has a moment where the buyer and the seller look at the same set of numbers and see completely different businesses. The seller sees the pipeline they just landed, the new contract about to start, the growth that's been building for two years. The buyer sees what can be verified today, what has actually shown up in the financials, and how much risk they're taking on things that haven't happened yet. The gap between those two views is where deals die. And it's where earnouts come in — a mechanism that says: we don't agree on what this business is worth today, so let's agree on what it needs to prove, and I'll pay for the proof when it arrives.
These three terms get confused constantly, even by brokers. They're different mechanisms that solve different problems.
Earnout
Part of the purchase price is contingent on the business achieving specific performance targets after settlement. If the targets are met, you pay. If they're not, you don't (or you pay less). The amount is variable.
Deferred consideration
Part of the purchase price is paid at a later date, but the amount is fixed. There's no performance condition — it's simply a timing arrangement. You owe the money regardless of how the business performs. Think of it as vendor finance without the interest.
Vendor finance
The seller lends you part of the purchase price, which you repay with interest over an agreed period. The amount is fixed, the repayment schedule is fixed, and it's documented as a loan. See our vendor finance guide for full detail.
The key distinction: an earnout is performance-linked — you only pay if the business delivers. Deferred consideration and vendor finance are time-linked — you pay regardless of performance, just later than settlement.
In practice, many deals combine these mechanisms. You might pay 50% at settlement, 20% as deferred consideration at 12 months, and 30% as an earnout tied to revenue targets over 24 months. Understanding which piece is which matters enormously for your risk profile and your legal documentation.
Use an earnout when
Don't use an earnout when
This is where most earnout structures succeed or fail. The metric needs to be relevant to the value being disputed, clearly measurable, and resistant to manipulation by either party.
Revenue
The simplest and hardest to manipulate. Revenue is verifiable against BAS lodgements and bank statements. The downside: a revenue target doesn't account for profitability. As the buyer running the business, you could theoretically chase low-margin revenue to hit the target — or defer invoicing to depress it.
EBITDA
Aligns better with business value but introduces complexity. EBITDA involves judgment calls on expenses, one-off costs, and discretionary items. As the buyer, you control the expenses — which the seller's lawyers will try to restrict. EBITDA earnouts generate the most disputes.
Gross profit
Sits between revenue and EBITDA. Captures whether the business is generating real margin but excludes the overhead decisions that make EBITDA contentious. A good compromise for service businesses.
Customer retention
Works well for owner-dependent businesses. For example: "80% of the top 20 customers by revenue remain active 12 months after settlement." It's binary and directly addresses the key risk. The challenge is defining "active" — does a customer who reduced spend by 90% count as retained?
Project or contract-specific
The cleanest approach when the valuation gap is driven by one or two identifiable opportunities. "If the Jones contract generates $200K+ revenue in the first 12 months, $100K additional consideration is payable." Specific, binary, measurable.
The practical recommendation: For businesses in the $500K–$5M range, revenue-based or contract-specific earnouts create the least friction. The more judgment calls your metric requires, the more likely you'll end up in a dispute. Keep it simple.
Typical earnout periods run 12–36 months. Shorter is better for everyone — the seller gets certainty sooner, and the buyer isn't constrained by earnout obligations for years. For small businesses, 12–24 months is the sweet spot.
Split long periods into measurement windows. A 24-month earnout with a single measurement at the end is riskier than two 12-month periods with separate targets and payments. If the first year falls short, both sides can see the trajectory and have a conversation, rather than waiting two years to discover a problem.
There are two common approaches to structuring the relationship between the metric and the payment:
Cliff earnouts: All-or-nothing. If EBITDA hits $400K, you pay $200K. If it hits $399K, you pay nothing. Clean and simple, but the cliff edge can lead to gaming — the seller may argue you deliberately kept EBITDA at $395K.
Scaled earnouts: Payment scales proportionally. For every dollar of EBITDA above $300K, you pay $0.50, up to a cap of $200K. This eliminates the cliff problem and creates a smoother incentive — both sides benefit from every incremental dollar of performance. Scaled earnouts generally cause fewer disputes.
Always cap the earnout. The seller's maximum additional payment should be defined upfront. An uncapped earnout creates unlimited exposure and perverse dynamics. Define the maximum, agree on it, and move on.
Specify in the agreement exactly how the metric will be calculated: which accounting standards apply, whether the calculation follows the same methodology the business used historically, what's included and excluded (one-off items, related party transactions, new revenue you introduced versus organic growth), and who prepares and reviews the calculation.
A common approach: the buyer's accountant prepares, the seller's accountant reviews, and a mutually agreed independent accountant resolves disputes. Also attach a worked example to the agreement — literally show how the earnout calculation would work using the current year's numbers. This forces both sides to agree on methodology before settlement, not after.
The seller will want protections to ensure you don't tank the metrics. You want the freedom to run the business as you see fit. Neither position is unreasonable. Common seller protections include maintaining minimum staffing levels, not changing pricing without consultation, continuing existing marketing spend, and operating the business "in the ordinary course."
The honest advice: If the operational covenants are so restrictive that you can't implement the changes you planned, either renegotiate the earnout structure or walk away from the earnout entirely and agree a lower fixed price. An earnout that handcuffs you for two years isn't worth the discount.
Earnouts have specific tax treatment under Australian law. This isn't legal advice — talk to your accountant — but here's the framework.
The look-through earnout right (s116-120 ITAA 1997): Since 2015, Australian tax law provides "look-through" CGT treatment for qualifying earnout arrangements. In plain terms: if the earnout meets certain conditions, the ATO treats each payment as an adjustment to the original sale price rather than as a separate taxable event. The seller doesn't have to guess the value of the earnout upfront for CGT purposes — they just report each payment as they receive it.
The conditions for look-through treatment: The earnout period can't exceed five years from settlement. The earnout must relate to the performance of the business. The right must be created as part of the sale arrangement. And the disposal must trigger CGT event A1.
Why this matters to you as the buyer: Each earnout payment you make adjusts your cost base in the asset you acquired. If you pay $1M at settlement and $200K in earnout payments over two years, your total cost base is $1.2M. This matters when you eventually sell, because a higher cost base means a lower capital gain.
Look-through treatment is generally favourable for sellers because it defers the tax liability. Understanding this gives you leverage in negotiation — the seller may prefer an earnout over a lower fixed price for tax reasons alone. Our asset sale vs share sale guide covers the broader CGT implications of deal structure.
Earnouts are the most litigated component of business acquisitions. Here's what goes wrong and how to design around it.
Common dispute
The buyer manipulated the metrics
The seller alleges the buyer loaded expenses into the earnout period, delayed invoicing, diverted opportunities to a related company, or made operational changes that depressed performance.
Prevention: Use revenue (harder to manipulate than EBITDA). Include anti-avoidance provisions. Specify that the business will be operated consistently with its historical practices. Require the buyer to provide monthly financials during the earnout period.
Common dispute
The buyer changed the business
The buyer merged the target with another business, changed the product offering, or restructured in a way that makes the earnout metric meaningless.
Prevention: Include an acceleration clause — if the buyer makes material changes without the seller's consent, the earnout is deemed achieved in full. This is powerful protection for sellers.
Common dispute
Disagreement on calculation
Both sides agree on what the metric is but can't agree on how to calculate it — different treatments of one-off items, different views on what's "ordinary course."
Prevention: Attach a worked example to the agreement showing the calculation using current year numbers. Include an independent expert determination clause for disputes — faster and cheaper than litigation.
Common dispute
The seller's involvement (or lack of it)
The seller agreed to stay on during the earnout period but didn't contribute, or left early and the buyer argues performance suffered as a result.
Prevention: Define the seller's role precisely — what activities, how many hours, for how long. Tie a portion of the earnout to the seller completing specific transition obligations, separate from the performance metric.
The business: A commercial cleaning company in Perth with $1.8M revenue and $320K SDE. The seller wants $1.3M. The buyer values it at $1M based on current financials (roughly 3x SDE).
The gap: $300K. The seller believes a new contract with a major property group (signed but not yet generating revenue) justifies the higher price. The buyer wants proof.
The structure:
| Component | Amount | Timing |
|---|---|---|
| Cash at settlement | $750K | Day 1 |
| Vendor finance | $250K at 6% over 18 months | Monthly from Day 1 |
| Earnout — Year 1 | Up to $150K | Paid at Month 13 |
| Earnout — Year 2 | Up to $150K | Paid at Month 25 |
| Maximum total | $1.3M |
The metric: Revenue. If Year 1 revenue exceeds $2M, the buyer pays $150K. If revenue is between $1.8M and $2M, the buyer pays a proportional amount ($150K × (actual revenue − $1.8M) / $200K). Below $1.8M, nothing. Same formula applies to Year 2.
The accounting: Prepared by the buyer's accountant using the same methodology as historical management accounts. Verified against BAS lodgements. The seller has the right to have their accountant review. Disputes go to an independent accountant agreed by both parties.
The operational covenants: Buyer operates in the ordinary course. No material changes to pricing, staffing, or service scope without the seller's written consent. Buyer provides the seller with monthly revenue reports within 15 business days of month end.
The seller's transition obligation: Seller remains available for 10 hours per week during Months 1–6 to introduce the buyer to key customers. Seller's availability is a condition of the earnout — if the seller fails to meet transition obligations, the earnout is reduced proportionally.
Why this works: The seller gets their $1.3M if the business delivers. The buyer pays $1M if it doesn't. Both sides have clear metrics, defined obligations, and a fair dispute resolution mechanism. The vendor finance provides the seller with certainty on $250K regardless of earnout performance. The scaled earnout eliminates cliff-edge gaming.
Earnouts sound fair in theory. In practice, they require careful design and a level of trust between buyer and seller that doesn't always exist — especially when you've just met through a broker listing.
The intelligence that determines whether an earnout is appropriate often isn't in the IM: Is there a pipeline that isn't yet in the financials? How dependent is the business on the owner's relationships? What's the seller's real motivation — and will they stay engaged through an earnout period? These are questions that come out in conversation, often between the lines. And they're the difference between an earnout that bridges a valuation gap and one that creates a two-year headache.
ThatDeal gathers the intelligence you need before you negotiate — including what's driving the seller's price and whether they'd consider an earnout structure.
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