Earn-Out Clauses in M&A

What Is an Earn-Out?

An earn-out is a deferred payment mechanism in a merger or acquisition transaction. Instead of paying the entire purchase price at closing, the buyer pays an initial amount at closing and agrees to pay additional consideration — the earn-out — if the acquired business meets defined performance targets in a specified post-closing period (typically 1 to 3 years).

Earn-outs are fundamentally a risk-sharing tool: they shift some of the performance risk from the buyer to the seller. From the seller’s perspective, they offer the opportunity to capture upside if the business performs well under new ownership; from the buyer’s perspective, they reduce the upfront price and align the seller’s incentives with business performance during the transition.

When Are Earn-Outs Used?

Earn-outs are particularly common in:

• Technology and service businesses where value lies in intangibles (software, contracts, talent) and future growth is uncertain
• Founder-led SMEs where the seller’s continued involvement is critical to maintaining revenue post-closing
• Acquisitions of businesses in cyclical sectors where recent results may not be indicative of normalised performance
• Transactions with a valuation gap — the seller believes the business is worth more than the buyer is willing to pay with certainty upfront

In Spain, earn-outs are frequently found in acquisitions of professional services firms, SaaS companies, and distribution businesses where customer relationships are personal to the founder-seller.

Earn-Out Metrics

The choice of metric is the most consequential drafting decision in an earn-out:

Revenue-Based Earn-Out

Simple and easy to measure: the earn-out triggers if the business achieves defined revenue (or recurring revenue) thresholds. The seller prefers this because it is harder for the buyer to manipulate through cost allocations. The buyer dislikes it because high revenue may be achieved at poor margins if the buyer increases investment.

EBITDA-Based Earn-Out

Based on the profitability of the business. More aligned with value creation but susceptible to manipulation through accounting choices, cost allocations from the buyer’s group, and intercompany pricing. Requires extensive definition of how EBITDA is calculated and what adjustments are permitted.

Gross Profit

A middle ground — measures revenue less direct costs, excluding the overhead allocation disputes that plague EBITDA earn-outs.

Non-Financial KPIs

In technology transactions: active users, customer retention rates, product milestones, regulatory approvals. Useful when financial metrics are not yet meaningful (early-stage businesses), but requires precise definition of measurement methodology.

Key Drafting Issues in Spanish M&A Earn-Outs

Accounting Definitions

The earn-out SPA must precisely define how the metric is calculated: which accounting standards apply (Spanish GAAP or IFRS), how intercompany transactions are treated, what adjustments are made for one-off items, and how the buyer’s post-closing changes (acquisitions, disposals, restructuring) affect the earn-out calculation.

Buyer Conduct Covenants

The seller’s biggest concern is that the buyer will deliberately or inadvertently manage the business in a way that reduces the earn-out — by shifting revenues out of the earn-out perimeter, loading costs into the acquired entity, or making strategic decisions (e.g., price reductions to win market share) that suppress short-term profitability. The SPA should include:

• An obligation to operate the business in the ordinary course (en el curso ordinario del negocio)
• Restrictions on material changes to accounting policies
• An obligation to provide adequate resources and not to interfere with the earn-out business
• Restrictions on intercompany transactions that would disadvantage the earn-out entity

Seller’s Post-Closing Role

Earn-outs typically involve the seller remaining with the business as an employee or consultant. The SPA should address: what happens to the earn-out if the seller is terminated (with or without cause), if the seller voluntarily resigns, or if the buyer prevents the seller from achieving the targets.

Good Leaver / Bad Leaver Provisions

These contractual mechanisms, borrowed from venture capital practice, affect the earn-out amount depending on how and why the seller’s employment ends. A “good leaver” (e.g., terminated without cause) typically retains full earn-out rights; a “bad leaver” (terminated for gross misconduct) may forfeit part or all. These provisions are heavily negotiated and must be carefully drafted to reflect Spanish employment law constraints.

Earn-Out Dispute Resolution

The SPA should specify who prepares the earn-out accounts, what the review and objection procedure is, and how disputes are resolved (typically an independent accountant or expert determination within a tight timeframe, rather than full litigation).

Tax Treatment of Earn-Outs in Spain

For the seller, the earn-out payments received in future years are treated as additional purchase price and taxed as capital gains in the year received. For individual sellers, this falls under the general savings base (base del ahorro) subject to IRPF at 19–28% depending on amount. For corporate sellers, the gain is taxed under Corporate Tax (potentially exempt under the participation exemption if qualifying conditions are met).

For the buyer, earn-out payments are treated as additional acquisition cost of the shares or assets, increasing the buyer’s tax basis. No deduction arises in the year of payment.

Common Earn-Out Disputes

Spanish M&A litigation frequently arises from earn-out provisions, particularly regarding:

• Disputed accounting treatments (EBITDA adjustments)
• Buyer’s failure to comply with conduct covenants
• Allocation of group overheads to the earn-out entity
• Determination of whether a triggering event has occurred

Courts and arbitration tribunals generally interpret earn-out provisions strictly against the party that drafted them and look to the evident commercial intent of the parties.

Frequently Asked Questions

What is a typical earn-out period in Spain? One to three years post-closing is most common. Longer periods increase uncertainty and the risk of disputes; shorter periods may not allow enough time to demonstrate performance, particularly in businesses with long sales cycles.

Can earn-out rights be transferred or assigned? Generally, earn-out rights are personal to the seller and are not transferable without buyer consent, particularly when the earn-out is linked to the seller’s continued involvement. The SPA should expressly address assignability.

What is a “ratchet” structure? A ratchet is a variant of an earn-out where the share of the business that the seller retains (or earns back) increases as performance milestones are met. Common in management buy-ins and PE transactions.

Does an earn-out constitute contingent consideration under IFRS 3? Yes, in the buyer’s consolidated accounts under IFRS, earn-out obligations are recognised as contingent consideration at fair value at the acquisition date, with subsequent changes recognised in profit or loss. This can create accounting volatility for listed acquirers and is a reason some buyers prefer fixed-price structures.

Is an earn-out enforceable under Spanish contract law? Yes. An earn-out is a contractual obligation under Spanish contract law (Código Civil and Código de Comercio). If the buyer fails to pay a triggered earn-out, the seller can bring a contractual claim. The difficulty lies in proving that targets were met or in demonstrating that the buyer’s conduct prevented target achievement.

How BMC Can Help

We draft, negotiate, and advise on earn-out provisions in Spanish M&A transactions — for both buyers and sellers. Our team covers the legal drafting, accounting definitions, tax structuring, and dispute avoidance mechanisms that make earn-outs work in practice rather than generating post-closing conflict.