Earnout Arrangements: Structuring Smarter Business Sales in Australia

Selling or buying a small business often involves a gap between what the seller believes the business is worth and what the buyer is willing to pay today. An earnout arrangement can bridge that gap without derailing the deal.

Put simply, an earnout lets part of the purchase price be paid later, based on how the business performs after completion. It can be a practical way to align incentives, reduce risk, and close the valuation divide-provided it’s structured correctly and documented clearly.

In this guide, we’ll unpack what an earnout arrangement is, when it’s useful, how to structure one step-by-step, the key legal issues to watch, and what to include in your contracts so both sides are protected.

What Is An Earnout Arrangement?

An earnout arrangement is a mechanism in a business sale where a portion of the purchase price is contingent on the target business meeting agreed performance metrics after completion. Instead of paying the entire price upfront, the buyer pays a base amount on completion and then further amounts (the earnout) if milestones are achieved over a set period.

For example, you might agree that the seller will receive an extra $300,000 over two years if revenue or EBITDA hits specific targets. If those targets aren’t met, the earnout may reduce or not be payable at all, depending on the deal.

Earnouts can be used in both asset sales and share sales. Deciding between a share sale vs asset sale is a strategic choice that affects tax, risk allocation and how an earnout is implemented in the documents.

When Do Small Businesses Use Earnouts In Australia?

Earnouts are common when a business’s future performance is promising but not guaranteed. Typical scenarios include:

• Growth-stage businesses with strong pipelines or contracts that haven’t fully converted yet.
• Owner-dependent businesses where the seller will help transition customers post-sale.
• Businesses affected by recent market disruptions, where a short track record doesn’t reflect steady-state performance.
• Sales involving new products, channels or regions-the upside is there, but needs time to prove out.

For buyers, an earnout limits overpaying for projections that don’t eventuate. For sellers, it’s a chance to capture the upside they believe is real-especially if they’re confident in the handover and the growth plan.

Before you commit, it’s important to do thorough due diligence so the earnout metrics rest on sound financial and operational information.

How To Structure An Earnout Arrangement (Step By Step)

Every deal is different, but most earnouts cover the same core building blocks. Here’s a practical, step-by-step way to frame your earnout so it’s fair, clear and workable.

1) Choose The Performance Metric

Select a metric that truly reflects the value drivers of the business and is hard to manipulate. Common choices include:

• Revenue or gross profit (simpler to measure, but can ignore cost changes).
• EBITDA (captures margin discipline, but needs clear accounting rules).
• Customer numbers, retention, or contract wins (useful for subscription or contract-heavy businesses).

Whichever metric you pick, define it precisely in the agreement-including what’s in or out, how it’s calculated, and any accounting policies that apply.

2) Set The Earnout Period And Tranches

Decide how long the earnout will run (often 12-36 months) and whether payments are made annually or at the end. Shorter periods are simpler; longer periods may better capture the true performance trajectory but introduce more variables.

3) Agree The Targets And Thresholds

Targets should be realistic and tied to an agreed business plan. Consider using thresholds and tiers, for example:

• Below Threshold A: No earnout payable
• Between A and B: Pro-rata earnout
• At/Above B: Maximum earnout payable (cap)

Pro-rata mechanics can reduce the “all or nothing” risk and feel fairer to both sides.

4) Build In Floors, Caps And Clawbacks

Most earnouts include a cap (maximum payable) and sometimes a floor (minimum payable if near-miss). Some buyers also seek clawbacks if subsequent periods underperform or if targets are hit in a way that triggers later losses. Make sure these mechanisms are very clear.

5) Lock Down Accounting Policies And Audit Rights

Disputes often stem from how results are measured. Specify the accounting policies and consistency requirements, access to management accounts, and any independent audit or expert determination process for disagreements.

6) Govern How The Business Will Be Run

Sellers want confidence the buyer won’t starve the business and miss targets; buyers need freedom to run the business prudently. A balanced approach is to include:

• Good faith obligations on both parties regarding the earnout.
• Reasonable endeavours to run the business consistent with an agreed plan or budget.
• Restrictions on extraordinary changes that would unfairly affect the metric (e.g., allocating unrelated head-office costs to the target).

7) Decide How You’ll Pay The Earnout

Earnouts are usually paid in cash, but sometimes equity is offered. If any part of the price is deferred on terms akin to credit, you may also need a complementary Vendor Finance Agreement to set out interest, security and default rights.

8) Plan For People And Transition

If the seller (or key staff) will stay on to help hit targets, align their role, employment terms and incentives with the earnout. This is best documented alongside the sale with the right employment or contractor arrangements, restraints and handover obligations.

Key Legal Issues To Consider Before You Agree To An Earnout

Earnouts are powerful-but they come with moving parts. Here are the big legal questions to work through up front.

Clear Definitions And Drafting

A well-drafted earnout schedule removes ambiguity. Define every variable (metrics, calculation methods, period, payment dates, caps/floors, and dispute resolution). If something can be reasonably interpreted two ways, assume a dispute later and clarify it now in the documents.

Business Conduct During The Earnout

Agree how operational decisions might affect the metric. For example, will major capital expenditure be excluded from EBITDA calculations? Can the buyer merge the target into another entity or must the business be run separately for measurement purposes? Spell this out to prevent disagreements.

Access To Information

Sellers usually need timely access to management reports to verify performance and calculation. Set out what reports will be provided, when, and any audit or expert determination rights if you hit an impasse.

Warranties, Indemnities And Adjustments

Earnouts rely on baseline information. If historical figures turn out to be incorrect, consider how that impacts the earnout (e.g., adjustments or indemnity claims). These protections typically sit within the main Business Sale Agreement alongside standard risk allocation clauses.

Employee And Restraint Considerations

Where the seller remains, you’ll want consistent roles and clear expectations so earnout targets are achievable. Restraint and non-solicit clauses help protect the buyer’s investment during the earnout period.

Customer Contracts And IP

If the earnout depends on retaining key customers or IP, ensure assignments, novations and registrations are handled at completion. Gaps here can undermine post-completion performance and frustrate the earnout.

Confidentiality And Communications

Both parties should protect sensitive information during and after the earnout. It’s common to have a standalone Non-Disclosure Agreement early in negotiations, then robust confidentiality clauses in the sale agreement.

Tax And Accounting Treatment

Earnouts can raise tax timing and characterisation issues. The commercial documents should align with the intended tax position, and you should seek accounting and tax advice to confirm how payments will be treated on both sides. While we focus on the legal aspects here, it’s wise to coordinate legal drafting with your accountant.

What Should Your Contracts Include?

The earnout sits within a broader suite of sale documents. Getting these right reduces friction during the earnout period and beyond.

The Business Sale Agreement (Or Share Sale Agreement)

This is the core contract that sets out the deal, including the earnout schedule. It will cover price, completion deliverables, warranties and indemnities, restraints, and dispute resolution. If you are buying or selling shares, the specific document is a Share Sale Agreement; for an asset deal, it’s typically a Business Sale Agreement.

Earnout Schedule Or Annexure

Most deals include a detailed schedule that defines the performance metrics, accounting policies, calculation examples, reporting timelines, and payment mechanics (including caps/floors and any acceleration or forfeiture events).

Vendor Finance Or Deferred Consideration Terms

If any portion of the price is deferred or contingent in a way that resembles credit, set out interest, security, events of default and enforcement in a dedicated document or section-often as a linked Vendor Finance Agreement.

Transitional Services

If the seller will provide services post-completion (e.g., management support, introductions, training) to help hit earnout targets, include a transitional services schedule that outlines scope, KPIs, fees (if any), and how performance ties into the earnout period.

Employment And Contractor Agreements

Where key people stay on, use tailored employment or contractor agreements with appropriate restraint and confidentiality terms that complement the earnout incentives and timelines.

Completion Deliverables And Handover

A thorough completion checklist helps you collect critical items at settlement-customer and supplier consents, IP assignments, key passwords and access rights-so the business can perform as planned during the earnout.

Dispute Resolution And Expert Determination

Earnouts occasionally trigger disagreements. Include a tight dispute resolution process for calculation disputes-often an expert determination by an agreed independent accountant whose decision is final, plus de-escalation steps before formal action.

Confidentiality And Public Statements

Control the narrative around the sale and the earnout. Clear rules on announcements, investor communications and customer messaging reduce confusion and protect goodwill.

Practical Tips To Make Your Earnout Work

• Keep it simple. The more complex the metric, the greater the chance of disagreement. Fewer moving parts often means fewer surprises.
• Tie targets to a realistic budget. If the budget changes, include a process to revisit targets cooperatively.
• Align incentives for key people. If management needs to deliver the earnout, make sure their compensation plan supports that goal.
• Document business-as-usual assumptions. If you’re assuming a certain marketing spend, team size or pricing model, put those expectations in writing.
• Plan governance. Regular check-ins, reporting timetables and a named liaison on each side keep everyone aligned.

If you’re at term sheet stage, it’s smart to have a lawyer frame the earnout mechanics early so your heads of agreement aligns with what can actually be drafted into the definitive documents.

Process: From Heads Of Terms To Completion (And Beyond)

Most earnout deals follow a familiar path:

1. Initial discussions and confidentiality (often under a Non-Disclosure Agreement).
2. High-level commercial agreement (term sheet) that outlines earnout concept and key parameters.
3. Financial and legal due diligence.
4. Drafting and negotiating the Business Sale Agreement and earnout schedule (or the relevant share/asset agreements).
5. Settlement with a robust completion checklist.
6. Post-completion reporting, handover and governance through the earnout period.
7. Assessment of metrics and earnout payments, with audit/expert determination processes available if needed.

If you’re buying shares rather than assets, your earnout will integrate into the Share Sale Agreement, and you’ll want to think carefully about historical liabilities and how warranties/indemnities interact with future performance.

Common Alternatives To Earnouts

Earnouts aren’t the only way to reconcile valuation differences. Depending on your deal, you might consider:

• Price adjustment mechanisms (e.g., completion accounts or locked box) to true up working capital and net debt at settlement.
• Retention or escrow arrangements to cover specific risks while keeping price certainty.
• Deferred consideration with fixed instalments (no performance condition) where cash flow is the issue, not valuation.
• Equity in the buyer group so the seller shares in longer-term upside beyond a fixed earnout period.

The right mechanism depends on whether the concern is performance risk, cash timing, or specific identified risks. Your legal and financial advisors can help match the structure to the actual problem you’re solving.

Key Takeaways

• An earnout arrangement lets part of the purchase price be paid later based on performance-useful when there’s a valuation gap or uncertainty in future results.
• Choose clear, objective metrics, lock down accounting policies, and define caps, floors and dispute processes to reduce the chance of disagreements.
• Balance operational freedom with fair protections-set reasonable governance and information rights so both parties can track performance confidently.
• Document the earnout in the core sale contract (asset or share) with a detailed schedule, and consider linked documents like a Vendor Finance Agreement, transitional services, restraints and employment terms.
• Plan your process from term sheet to completion and through the measurement period, with reporting timetables, audit rights and expert determination clauses.
• Get coordinated legal and accounting input early so the commercial plan, tax treatment and legal drafting all line up.

If you would like a consultation on structuring an earnout arrangement for your business sale, you can reach us at 1800 730 617 or team@sprintlaw.com.au for a free, no-obligations chat.