Earn-Outs in M&A

What an earn-out is and when it is used

An earn-out (in Czech, “výstupní odměna” or “dosáhnutí výsledků”) is a part of the purchase price that is paid either in instalments or as a lump sum after the transaction closes, and its amount depends on whether the sold company meets pre-agreed targets.

A typical earn-out has several components:

• Fixed base : An immediate payment upon signing/closing (for example, 60–70% of the purchase price).
• Variable earn-out : The remaining 30–40% is paid over the next 1–3 years depending on whether the metrics are achieved.

Practical example: You are selling an e-commerce company with annual revenue of CZK 50 million. The buyer is willing to pay CZK 100 million, but only if they can verify that the company will remain profitable and will not lose key clients. You agree on an earn-out: CZK 70 million upfront, with the remaining CZK 30 million paid after three years if revenue does not fall below CZK 45 million per year.

Earn-outs are particularly popular in the following situations:

• Private equity and venture capital deals : Investors insure their acquisition against declining performance.
• Sale of scaling startups : The seller wants to secure value if the company develops better than the buyer expects.
• Transactions in fragmented industries : Where it is difficult to predict future development (for example, franchises, technology services).
• Internal sales in family businesses : The new owner (for example, a son taking over the business) is incentivized to continue growth.

Why an earn-out seems attractive – and where the problems lie

At first glance, an earn-out looks like a win-win solution: the buyer is not willing to pay the full price without evidence of future performance, while the seller can achieve a higher total price if things go well. The reality, however, is significantly more complex. For a practical overview of the legal and tax issues that typically complicate pricing mechanisms in exits, see How to Prepare a Company for Sale: Legal and Tax Issues That Most Often Derail the Entire Transaction. When setting up an earn-out in an M&A transaction, it therefore pays to rely on experience with company sales and transaction advisory, especially when drafting metrics and control mechanisms.

Problem 1: Defining the metric and manipulating results

An earn-out must be tied to specific, measurable metrics. The most commonly used are:

• Revenue
• EBITDA (earnings before interest, taxes and depreciation)
• Net profit
• Number of active clients
• Client retention rate

The problem: Even after the transaction, the new owner has influence over how these metrics are calculated and interpreted. For example, they may:

• Change accounting methods (e.g., the timing for recognizing revenue).
• Deplete the company’s resources on projects outside the earn-out period.
• Shift profits to another subsidiary within the group.
• Lower prices and squeeze profits to avoid paying the earn-out.

Our attorneys in Prague at ARROWS see these situations almost regularly. If the earn-out later turns into a disagreement over calculation or access to information, the dispute often ends up in court or arbitration—see Commercial Litigation & Arbitration in the Czech Republic. A practical framework for how to identify and address similar risks before signing the agreements is also summarized in the article Vendor Due Diligence: Why have your own company reviewed before the buyer does?. The seller believes they will receive the earn-out, but the buyer achieves—through “creative” accounting—that the metric is not met.

Problem 2: Loss of control over the company

After the sale closes, you lose decision-making authority. The new owner decides how the company develops, what it invests in, what the working conditions are, the market strategy, etc. All of these decisions affect the earn-out metrics, but you have virtually no ability to intervene. A structured approach to setting control rights, information covenants and post-closing protections is discussed in Why Legal Support Is Essential in M&A Transactions: Key Risks and Phases.

Example: You sell a marketing agency with an agreement that the earn-out is calculated based on the client retention rate. The new owner decides to cut costs and disbands half the team. Clients leave, the retention rate drops, and the earn-out is not achieved.
Legally, it is their right; you can only watch with an exhausted budget for legal services. If a dispute starts to take shape already during the earn-out period, it is advisable to address procedural strategy and the evidentiary position in good time within commercial and litigation disputes.

Problem 3: Disputes and lengthy legal battles

When an earn-out is complex and drafted ambiguously, the buyer and seller often disagree on whether the metric was actually achieved. This leads to:

• Disputes over how the metric is calculated.
• Requests for audits and financial reviews.
• Mutual accusations of manipulation.
• Lengthy legal disputes that can last for years.

Attorneys from ARROWS advokátní kancelář encounter cases where earn-out dispute resolution drags on for more than three years and the seller manages to recover only part of what they expected. Typical triggers of these conflicts include deficiencies identified during a company due diligence review, as described in the news article How to Prepare a Company for Sale: Legal and Tax Defects That Most Often Derail the Entire Transaction.

Structuring an earn-out: How to protect your interests

So that an earn-out is not just a lottery, you must structure it properly. Here is a step-by-step guide:

Define the metrics with maximum precision

Do not settle for vague wording such as “good performance” or “increased profitability”. The metric must be numerical, measurable, and verifiable.

Good metrics:

• EBITDA in the range of CZK 10–12 million in the second year (a specific figure, a specific year).
• Revenue exceeds CZK 80 million and the retention rate is at least 85%.
• The number of active users reaches at least 50,000.

Bad metrics:

• “The company will remain profitable” (what does profitable mean? by how much?).
• “Customer loyalty will increase” (by how much?).
• “Turnover will increase” (by what percentage, over what period?).

Define the calculation of the metric with maximum transparency

The agreement must state precisely how the metric is calculated:

• Which data are taken from the accounts?
• What is included in each line item (what is included in EBITDA and what is not)?
• How are one-off costs, reforms, or restructuring expenses treated?
• What exceptions apply?

An example of specificity: “EBITDA is calculated from the statutory financial statements verified by the auditor, excluding: one-off bonuses for the new team, IT migration costs, one-off legal fees, and goodwill amortisation.”

Set your audit rights

The seller should have the right (at its own cost) to have the earn-out results verified by an independent auditor. The agreement should include:

• Whom the seller may appoint to perform the audit (which auditor, what qualifications).
• When the audit may be requested (e.g., within 60 days after year-end).
• What the auditor must verify (access to accounting records, documents, contracts).
• Who bears the audit costs (typically the seller if the audit confirms the buyer’s calculation; the buyer if material discrepancies are found).

Cap the earn-out amount at a reasonable level

Do not tie too much of the total purchase price to the earn-out, so that its calculation does not jeopardise the company’s operations. Typical ranges:

• Conservative approach: 15–25% of the total purchase price.
• Mid-range approach: 25–40%.
• Aggressive approach: 40–50% (higher risk).

Earn-outs above 50% are rare and typically relate to startups with a highly uncertain future.

Secure your right of oversight

Even if you will no longer be the owner, you should have the right to:

• Access to accounting records and financial reports (at least quarterly).
• Information about key changes (dismissal of key personnel, pricing changes, loss of key clients).
• The option to engage an independent auditor.
• You should also agree that the buyer will not change the company’s operations in a way that demonstrably jeopardises achieving the earn-out, or negotiate a right to compensation in such a case.

Most common problems with earn-out agreements in practice

In practice, we encounter a number of problematic aspects of earn-out agreements that often lead to disputes.

Problem: Unclear definition of KPIs (Key Performance Indicators)

Sometimes the parties agree on “EBITDA” but do not address how exactly it is calculated. One party uses one formula, the other uses a different one. The result: a dispute over millions.

Attorneys from ARROWS advokátní kancelář draft earn-out agreements so that these ambiguities are eliminated before signing.

Problem: No dispute resolution mechanism

If the parties disagree, what happens? Will it go to court? To arbitration? How long will it take? If it is not defined, chaos arises.

Problem: The earn-out is tied to matters outside the seller’s control

Example: You sell an online store on the condition that the earn-out is calculated based on website traffic. But if the buyer redesigns the site and traffic drops, you will not be able to complain—it is not your fault.

Problem: No one addresses what happens if the sold company is sold on during the earn-out period.

The buyer tells you: “Come on, I’ll have hold-backs for ten years, but I’ll sell the company in a year. Your earn-out will also be ‘sold’ to the new buyer.” You do not even know the new buyer and you do not know whether they will pay the earn-out. That is a problem.

Risk and protection table

Earn-out and tax implications

An earn-out also has tax consequences. Earn-out payments are taxed as income from business activities (if you are self-employed) or as income from other sources (if you are an individual without business activities). In the Czech Republic, this typically means:

• Social security and health insurance contributions (if you are operating as a business).
• Personal income tax (15% or according to your progressive tax rate).
• And potentially VAT (value added tax) obligations, if the earn-out is not part of the purchase price for the transfer of an enterprise or a shareholding, but instead constitutes consideration for another VATable service or supply.

Important: The tax treatment of an earn-out differs depending on whether you sell as an individual versus a legal entity, and whether the sale is within the Czech Republic or cross-border (in EUR, USD, etc.).

Our Czech legal team at ARROWS, a Prague-based law firm, can arrange a consultation with tax advisors so that your earn-out is structured in a tax-efficient manner.

Case study: How an earn-out becomes a problem

An entrepreneur in the IT sector sold his company for CZK 80 million: CZK 50 million upfront, and CZK 30 million as an earn-out tied to revenues not falling below CZK 40 million per year over the next two years. The agreement was short and vague.

After six months, the entrepreneur notices that the buyer changed the product pricing and let go of a large portion of clients. Revenues drop to CZK 35 million. The entrepreneur contacts the buyer, who says: “The agreement doesn’t say I can’t change the strategy. You’ve just seen that revenues can change – so the earn-out will of course not be paid.”

The entrepreneur pushes back, but without a clear agreement he has no leverage. He goes to a lawyer and learns that the legal fight will take two years and cost hundreds of thousands. In the end, he receives only part of the earn-out, with his budget for legal services depleted.

Lesson learned: Without a clear earn-out agreement, audit rights, and a clear dispute-resolution mechanism, you will find yourself in a powerless position.

Cross-border earn-outs and ARROWS International

If you are a foreign company selling a Czech company, or you have a Czech buyer outside the Czech Republic, or if the buyer is based outside the Czech Republic, the earn-out becomes more complex. The following questions arise:

• Which law governs it? (Czech law vs. the buyer’s country).
• How is a decision enforced abroad?
• What currency risk is borne by an earn-out tied to a foreign currency?

Our attorneys in Prague at ARROWS, a Prague-based law firm, have access to the ARROWS International network, enabling them to arrange legal representation in several European countries. If the earn-out involves an English, German, or Austrian company, ARROWS can handle more complex transactions, including coordination with lawyers in those jurisdictions.

How to safeguard your earn-out: Practical tips

• Have a high-quality earn-out agreement prepared by a lawyer. Not by the seller or the buyer. A neutral lawyer ensures the agreement protects both parties and is enforceable in court.
• Define audit rights clearly. Do not waive access to accounting records. You should have the right to access all relevant documents.
• Choose arbitration, not court. Court disputes take years. The agreement should include a clause for dispute resolution through arbitration, which is usually faster.
• Insure your earn-out. There is insurance for non-performance of an earn-out (earn-out insurance). It is not cheap, but it eliminates the risk.
• Do not tie too much of the total purchase price to the earn-out. If the earn-out makes up more than 40% of the total price, you are taking on too much risk.
• Communicate expectations with the buyer. If the seller and buyer align on operational strategy and objectives, disputes are less likely.

Final summary

An earn-out is an attractive tool for selling a company at a higher price, but only if it is properly structured and protected. Without high-quality legal documentation, you risk the buyer manipulating results, the earn-out not being paid at all, or being drawn into a lengthy legal dispute lasting years.

Key points to remember:

• Metrics and their calculation must be as accurate as possible. No ambiguity, no room for different interpretations.
• Audit rights are your insurance policy. Secure access to the accounts and the right to an independent audit.
• Disputes are better resolved through arbitration than in court. Define this in the agreement in advance.
• Manipulation of results is a real risk. The buyer is incentivised to reduce the earn-out because it effectively saves them money.
• An earn-out does not mean full control. After the sale, you no longer decide how the company develops.

If you do not want to risk mistakes that commonly arise in earn-out agreements, the safest approach is to have the transaction prepared and supervised by the attorneys at ARROWS, a Prague-based law firm. We will draft an agreement with maximum legal and practical protection, safeguard your audit rights, and, in the event of a dispute, represent you in court or in arbitration.

Do you want to secure your earn-out with high-quality legal preparation? Email us at consultation@arws.cz – we will be happy to help you structure the sale of your company so that your investment is truly protected.

Read also:

• Pre-Closing Dividends and Working Capital Adjustments in M&A Deals
• Vendor Due Diligence: Protecting Value and Price in Company Sales
• Selling a Company: From Letter of Intent to Closing Key Pitfalls
• Why Legal Support Is Essential in M&A Transactions: Key Risks and Phases
• Preparing Your Company for Sale: Legal, Financial and Tax Steps to Maximise Value