Think tank: earn-out agreements can create as many problems as they solve

But in reality it is increasingly clear earn-outs can create as many problems as they solve. Anecdotal evidence suggests as many as half fail to pay out, either because targets are missed or because of other complications.

The problem is that, no matter how brilliantly constructed an earn-out is, it invariably skews the behaviour of both buyer and seller in unhelpful ways. Having made an acquisition, for example, the buyer is likely to want to integrate it into the larger business as quickly as possible. But if the earn-out payments are linked solely to the performance of the acquired firm, the seller will want to keep the two separate for as long as possible so their targets can be measured.

What’s more, the targets themselves can often become irrelevant, as markets, industries and technologies change.

As Howard Lee, senior partner at Cavendish Corporate Finance, puts it: “The best earn-out I’ve seen is where the purchaser gets to know a business, likes what they see and after six months says to the seller, forget the earn-out, we are going to pay you the full amount because we want to work with you and don’t want this getting in the way.”

Earn-outs will always have a role to play in the acquisition of radically innovative start-ups. But as the economy recovers and co-operation and collaboration become increasingly important drivers to growth, perhaps it is time firms stopped automatically writing an earn-out into every acquisition and thought a little harder about what they are really trying to achieve.

• Rachel Bridge is an author, public speaker and journalist specialising in entrepreneurship and SMEs

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