The earn-out that kept us working for three more years

There is a particular feeling that comes with the first serious offer for a business you built. Someone has put a number on it, in writing, and the number is larger than you privately expected. What almost nobody registers at that moment is how much of it is a number and how much of it is a hope.

Deals for small companies are very often structured as cash on completion plus an earn-out: a further sum, payable over two or three years, contingent on the business hitting agreed targets after you have sold it. It is a sensible instrument. It bridges the gap between a buyer who thinks your good year was luck and a seller who knows it was not. It is also the part of the deal that goes wrong most often, for reasons that are entirely predictable and mostly avoidable.

What an earn-out actually is

The shape is consistent. A headline price, say £2.4m. £1.5m paid on completion. A further £900,000 payable over three years if the business achieves stated financial targets — usually EBITDA, sometimes revenue, occasionally gross profit or a customer retention measure.

Two things follow immediately. First, the seller now has a large financial interest in a business they no longer control. Second, the buyer now has a large financial interest in that business narrowly missing its targets. Everything difficult about earn-outs flows from those two sentences sitting next to each other.

The tax nobody warns you about

This is the part that catches first-time sellers hardest, and it is settled law rather than a grey area.

When the earn-out is unascertainable — you cannot know at completion what it will pay, because it depends on future performance — the right to receive those future payments is itself treated as an asset you received as part of the sale price. This comes from the case of Marren v Ingles, and HMRC's Capital Gains Manual works through it from CG14850 onwards.

The practical consequence is severe. At completion you are taxed on the cash you received plus the market value of the right to the earn-out. That is a valuation of a promise, made now, on money that has not arrived and may never arrive. Then, as each earn-out payment is received, that is treated as a part disposal of the right, generating a further gain or loss.

And here is the sting: Business Asset Disposal Relief is only available on the initial disposal, including the valued right. The later receipts are disposals of a contractual right, not of a business asset, so they do not qualify. Whatever relief you were counting on covers the front end of the deal only.

You can be taxed at completion on the value of an earn-out that is later missed entirely, on a valuation somebody put on a promise the buyer subsequently had every incentive not to keep.

What the numbers look like now

The relief itself has changed, and sellers working from older advice are usually a rate behind. Business Asset Disposal Relief was charged at 10% for years. It rose to 14% for disposals on or after 6 April 2025, and to 18% for disposals on or after 6 April 2026. The lifetime limit stays at £1m of qualifying gains.

Set that against the main capital gains rates from 6 April 2026 — 18% within the basic rate band and 24% above it, with a £3,000 annual exempt amount — and the picture is stark. BADR is now worth six percentage points to a higher-rate payer, capped at the first £1m of gains. That is up to £60,000, which is real money and worth claiming properly, but it is no longer the deal-shaping relief it was when the gap was fourteen points.

For an earn-out seller that changes the arithmetic in a specific way. The relief you lose on the deferred slice costs you less than it used to, because there is less of it to lose. The exposure that has not shrunk at all is being taxed up front on a valuation of money that never turns up.

There is a remedy for exactly that, and it is worth knowing the name of. Where the right to unascertainable deferred consideration is later disposed of at a loss — because the earn-out paid less than the value attributed to the right at completion — an election under section 279A of the Taxation of Chargeable Gains Act 1992 lets an individual carry that loss back and treat it as accruing in the earlier year, setting it against the original disposal gain. Without the election, the loss sits in a later year where there may be nothing to set it against. It is one of the more useful provisions in the capital gains code and one of the easiest to miss, and it does not apply where the earn-out right is treated as a security under section 138A.

The commercial traps, in order of how often they bite

EBITDA is not a fact. It is the output of a hundred accounting choices, and after completion the buyer makes all of them. Central management charges, allocated group overheads, the cost of the buyer's own integration project, a different depreciation policy, a bonus scheme imposed on your team — each is defensible in isolation and each reduces the number your payment depends on. Define the measure precisely in the sale agreement, including which costs are excluded and which accounting policies are frozen for the earn-out period.

The buyer's plans are not your plans. They move your best salesperson to another division. They stop the marketing spend that fed your pipeline. They put your product on their price list at their margin. None of it is bad faith; all of it wrecks your targets. Negotiate positive protections — minimum marketing spend, headcount floors, no transfer of key staff without consent, the business run as a separate profit centre for the earn-out period.

All-or-nothing cliffs. A target of £1.2m EBITDA that pays £900,000 at £1.2m and nothing at £1.19m turns the last month of the year into a negotiation. Sliding scales, and multi-year targets that let a strong year offset a weak one, remove most of the incentive to argue.

Your own position. Most earn-outs come with a service agreement, because the buyer wants the person who built it still building it. You are now an employee, on notice, working towards a bonus you cannot control, in a business someone else runs. That is a real cost that never appears in the deal maths, and it is the honest subject of the first 90 days after selling your business.

Getting paid at all. The earn-out is an unsecured promise from a company that has just spent a lot of money buying yours. If it is highly leveraged, or the buyer is a vehicle with no assets of its own, the covenant behind your deferred consideration may be thin. Ask for a parent guarantee or an escrow, and if you are told the buyer is good for it, ask why they mind putting that in writing.

Would you do the deal without it?

The most useful test is the simplest one. Look at the completion cash on its own, ignore the earn-out entirely, and ask whether you would sell at that price. If the answer is yes, the earn-out is upside and you can negotiate it calmly. If the answer is no, you have not been offered £2.4m for your business — you have been offered £1.5m plus a job with a bonus scheme, and you should price and negotiate it as exactly that.

That framing also tells you where to spend your negotiating capital. Sellers routinely burn it arguing the headline multiple up by a tenth of a turn and then accept the earn-out drafting as a formality. The multiple moves the number on the press release. The drafting decides whether the money arrives.

What to do before you sign anything

Model three scenarios — targets hit in full, half hit, missed entirely — and put the tax on each, including the charge that falls at completion on the valued right. Get the earn-out right valued properly by someone who does it regularly rather than accepting a figure that suits the other side. Read the definitions schedule in the sale agreement more carefully than the price clause. Ask what happens if the buyer sells the business on, or restructures, mid-earn-out. And ask, plainly, who signs off the accounts the payment is calculated from, and what happens when you disagree with them.

None of this makes an earn-out a bad structure. Plenty of good deals are impossible without one, and it is often the only bridge between a fair price and a nervous buyer. But it should be entered with clear eyes: it is not deferred certainty, it is a bet on someone else's stewardship of the thing you built, with the tax charged at the start and the money paid at the end. That is also why working out what your business is actually worth matters long before an offer arrives, and why some owners end up looking hard at an employee ownership trust instead of a trade sale.

Common questions

How is an earn-out taxed in the UK?

Where the amount is unascertainable at completion, the right to receive the future payments is treated as an asset you received as part of the consideration, following Marren v Ingles. You are taxed at completion on the cash plus the market value of that right, and each subsequent payment is a part disposal of the right producing a further gain or loss. Business Asset Disposal Relief applies only to the initial disposal, because the later receipts are disposals of a contractual right rather than of a business asset. HMRC's guidance runs from CG14850 in the Capital Gains Manual, and the valuation of the right is set out at SVM107160.

What happens if the earn-out pays less than expected?

You will have a capital loss on the right to deferred consideration, because the value taxed at completion exceeded what actually arrived. Left alone, that loss falls in the later tax year and may have no gains to be set against. An election under section 279A of the Taxation of Chargeable Gains Act 1992 allows an individual to carry the loss back and treat it as accruing in the earlier year, so it can be deducted from the gain on the original sale. The election is not available where the earn-out right is treated as a security under section 138A, and it has to be claimed — nobody applies it for you.

What rate of Capital Gains Tax will I pay when I sell my business?

Business Asset Disposal Relief is charged at 18% for disposals on or after 6 April 2026, up from 14% for disposals from 6 April 2025 and 10% before that, with a £1m lifetime limit on qualifying gains. Gains outside the relief are taxed at 18% within the basic rate band and 24% above it, with a £3,000 annual exempt amount. In practice that means the relief is now worth six percentage points to a higher-rate taxpayer, capped at the first £1m of gains, so a maximum of £60,000. Still worth claiming, but no longer large enough to build a deal structure around.

How do I stop the buyer engineering the earn-out targets down?

Define the measure in the sale agreement rather than relying on ordinary accounting practice. Specify exactly which costs are excluded from the earn-out calculation — group management charges, allocated overheads, integration costs, buyer-imposed bonus schemes — and freeze the accounting policies used to prepare the figures. Add positive covenants: run the business as a separate profit centre, maintain minimum marketing spend and headcount, and do not transfer key staff without consent. Then agree the dispute mechanism in advance, naming an independent accountant as expert. Every one of these is negotiable while the deal is live and impossible to fix afterwards.

Should I take a lower price for all cash instead of an earn-out?

Very often, yes. Compare the certain sum against the risk-adjusted value of the deferred one, remembering that you will be taxed at completion on the value of the earn-out right whether or not it ever pays. Factor in the years of service the earn-out usually requires, the loss of relief on the deferred slice, and the buyer's creditworthiness as an unsecured debtor. A clean deal at a somewhat lower headline number can leave more cash in your hand and vastly less risk. The useful test is whether you would accept the completion payment alone; if not, the earn-out is not upside, it is the deal.