The part of the price you do not receive at closing

Two mechanisms that must stop being confused

An earn-out is a price supplement. Its amount is not known at signing: it depends on the company's future results. If the targets are not met, it is not due, and you have no recourse.

Vendor financing is a payment term. The amount is fixed and certain from signing, the buyer simply settles it later, generally in two or three annual instalments bearing interest. If the buyer does not pay, the debt remains due.

The difference is fundamental and it concerns the nature of the risk. With an earn-out, you bear a performance risk on a company you no longer run. With vendor financing, you bear a counterparty risk, that of not being paid by an identified debtor.

The second can be covered by guarantees. The first can hardly be covered at all, and that is why it must remain limited as a proportion of the total price. For tax purposes, the price supplement received under an indexation clause is taxable in the year it is received, which defers the taxation but does not remove it.

What an earn-out is really for

An earn-out appears when the seller and the buyer do not agree on the outlook. The seller values a growth they consider secured, the buyer does not want to pay for it in advance. The price supplement defers the disagreement to the facts.

It is particularly justified in three situations: a fast-growing company whose trajectory is not yet confirmed, a major contract being signed at the time of the sale, or a dependence on the owner-manager that the buyer wants to see recede before paying the full amount.

The parameters to set. The indicator chosen, the observation period, the calculation formula, the cap, and above all the role you keep during that period. On duration, two years are a good compromise. One year is too short to smooth out the ups and downs of a financial year. Three years tie you to a company you no longer control, and experience shows that the third year of an earn-out is rarely paid.

Why so many earn-outs go wrong. The cause is almost always the same: the indicator chosen can be influenced by the buyer.

Net profit is the worst possible choice. It depends on the depreciation policy, the financial costs linked to the acquisition structure, the management fees charged by the acquisition holding company and the provisioning choices. A buyer does not even need to act in bad faith: the normal financing of their deal is enough to crush the target's net profit.

EBITDA is better, provided it is defined. The agreement must specify the adjustments, exclude acquisition-related costs, regulate re-invoicing from the acquiring group and neutralise changes in accounting method. Turnover is the simplest and the least contestable: it is hard to manipulate and easy to verify. Its limit is real: a buyer can grow turnover while eroding the margin. It must therefore be paired with a minimum gross margin threshold.

The protective clauses to demand. Maintaining the scope during the period, a ban on transferring the business to another group entity, a ban on merging the company without neutralising the calculation, a right of access to the accounts and their detail, the continuation of the commercial and investment policy under normal conditions, and the triggering of full payment if the company is resold during the period. This last point is often forgotten: a buyer who resells after eighteen months realises their capital gain while your earn-out disappears in the restructuring.

Vendor financing, the tool that unlocks internal buyouts

Vendor financing consists of agreeing to be paid in several instalments. The price is firm, only the due date is deferred.

It is a decisive tool in buyouts by employees or by the family. An internal buyer rarely has a sufficient equity contribution, and banks cap their financing at a multiple of that contribution. Vendor financing bridges the gap and makes possible a deal that would otherwise not exist.

It also sends a strong signal to the financiers. A seller who agrees to carry part of the price over three years demonstrates that they believe in the strength of their company and in the buyer's ability. Banks read it that way and lend more willingly.

The usual parameters. A share of between 15 and 30% of the price, a term of two to five years, an interest rate aligned with market conditions, and a twelve-month deferral of the first instalment that gives the buyer time to stabilise their cash position.

Beware of a technical point. Capital gains tax is in principle charged on the full price in the year of the sale, including the portion not yet received. An owner-manager who grants substantial vendor financing may end up paying tax on money they have not received. Article 1681 F of the French General Tax Code allows the payment of this tax to be spread out, subject to conditions on the size of the company: it is a point to examine with a tax specialist before signing.

Securing payment of the deferred portion

An unsecured claim on a company that has just taken on debt to buy you out is a fragile position. Several forms of security are used, alone or combined.

• A pledge over the shares sold. If the buyer does not pay, you can recover the shares. It is the most natural and most effective guarantee, subject to an acceptable ranking behind the bank.
• The buyer's personal guarantee. Its effectiveness depends entirely on their actual wealth. In an internal buyout, it is often symbolic.
• A bank guarantee. The most solid, the rarest, because it consumes the buyer's borrowing capacity.
• Acceleration clauses. The balance becomes immediately payable in the event of payment default, resale, change of control or excessive dividend distribution.

A point of attention on ranking. The bank financing the acquisition will almost always demand to be served before you, with a subordination clause that prohibits any payment to the seller as long as certain ratios are not met. Read that clause carefully: it can push back your instalments by several years without the buyer themselves being in default.

How to choose between the two

The reasoning goes in three steps.

What is the nature of the disagreement? If it concerns the company's future value, the earn-out is the right tool. If it concerns the buyer's financing capacity, it is vendor financing. Using one to solve the other's problem produces shaky structures.

What proportion are you willing to defer? A prudent benchmark is to check that the sum received at closing, net of tax, covers your essential personal wealth needs. Everything deferred should count as a bonus, not as a necessity.

Who is on the other side? An individual buyer, an internal team and an investment fund do not present the same risk profile, and the structure must adjust accordingly.

There is a fourth way, which we implement regularly: an investor provides the missing capital at closing, which allows the seller to be paid in cash while making the deal accessible to an internal team. The risk is carried by the investor rather than the seller, and that is the investor's job. See how we structure these buyouts.