Earn-Outs in Business Sales: What You Need to Know

An earn-out is a contractual mechanism in which part of the purchase price for a business is contingent on the company's future performance. In the Portuguese M&A market, earn-outs have become increasingly common — particularly in deals where buyer and seller have different views on the company's future trajectory or where the business has significant growth potential that is not yet reflected in historical financials.

Typically, earn-outs represent 15-30% of total deal value and are measured over 1-3 years post-completion. The most common performance metrics include revenue growth, EBITDA targets, customer retention rates, or specific project milestones. The choice of metric is critical: it must be clearly measurable, resistant to manipulation by either party, and aligned with the company's genuine value drivers.

For sellers, the key risks include: loss of control over business decisions that affect earn-out performance, the buyer's ability to manipulate costs or revenue allocation to reduce earn-out payments, integration actions that disrupt the business during the measurement period, and the time value of money (deferred payments are worth less than upfront cash). Sellers should negotiate for protective provisions including continued involvement in key business decisions, access to financial information, and dispute resolution mechanisms.

For buyers, earn-outs carry their own risks: they can complicate post-acquisition integration by creating misaligned incentives, the seller may resist necessary changes that could reduce short-term performance, and disputed earn-out calculations can lead to expensive litigation. Buyers should ensure the earn-out structure allows them sufficient operational flexibility to manage the business effectively.

Portuguese law does not specifically regulate earn-out mechanisms, meaning the contract itself is the primary source of rights and obligations. This makes the drafting of the earn-out clause particularly important. Key elements include: precise definition of the performance metric(s), clear accounting policies to be applied, mechanisms for resolving disputes (typically independent auditor determination with escalation to arbitration), and provisions addressing change of control, material adverse events, and force majeure.

Our recommendation: use earn-outs only when genuinely necessary to bridge a valuation gap, and invest heavily in the contractual framework. A well-structured earn-out aligns incentives and creates value for both parties; a poorly structured one almost guarantees disputes.