Earn-Outs and Deferred Purchase Price: What Sellers Need to Protect

A RM12 million offer is not necessarily a RM12 million exit.

If RM8 million is paid at completion and the remaining RM4 million depends on the company hitting a revenue, EBITDA, customer-retention or other target after the buyer takes control, the seller has agreed to something very different from a clean cash sale.

The seller has transferred ownership now but remains economically exposed to what happens later.

That can be acceptable. An earn-out may bridge a genuine valuation gap, allow the seller to participate in future upside or make a deal possible when buyer and seller disagree about what the business will deliver next.

But the headline number should not distract from the real question: what has to happen before the seller actually receives the deferred value, and who controls whether it happens?

First, separate deferred consideration from an earn-out

These structures are often discussed together, but they create different seller risks.

Fixed deferred consideration is usually an agreed part of the purchase price that is payable later. The amount is already known; the seller's concern is whether and when it will be paid.

An earn-out is contingent. The amount depends on a future event or performance measure. The seller may receive all, some or none of the contingent amount depending on the agreed formula.

The distinction matters because the protections should be different.

For fixed deferred consideration, the seller should focus heavily on payment dates, credit risk, security, interest where relevant, acceleration, default and set-off.

For an earn-out, the seller must also focus on how the business is run, how performance is measured, who controls the inputs and what information the seller receives after completion.

Headline price and payment certainty are different things

A seller should break the proposed consideration into three buckets:

• cash or other value received at completion;

• fixed amounts payable after completion; and

• contingent amounts that may never become payable.

This produces a more realistic view of the deal.

A buyer may describe a transaction as being worth RM20 million, but if RM5 million is deferred for two years and another RM5 million is dependent on aggressive performance targets, the seller should not treat all RM20 million as equally certain.

The commercial negotiation should therefore focus not only on the maximum price but also on the probability, timing and enforceability of each component.

Define the earn-out formula before arguing about the target

"The seller receives RM3 million if EBITDA exceeds RM4 million" sounds clear until the parties ask how EBITDA will actually be calculated.

Which accounting policies apply? Are exceptional expenses excluded? How are management charges treated? What if the buyer moves employees, customers or costs between group companies? What if the business makes an acquisition? What happens to revenue received after the measurement date but relating to work completed before it?

The formula should therefore identify more than the target number.

A seller should be able to understand:

• the performance metric;

• the measurement period;

• the accounting principles and consistency rules;

• what items are included or excluded;

• how exceptional or one-off items are treated;

• how group charges and related-party transactions are handled;

• whether the calculation is linear, stepped or all-or-nothing; and

• the maximum amount payable.

If the formula cannot be tested using realistic numbers before signing, it is not ready.

Accounting policy can change the earn-out without changing the business

Two people can look at the same trading performance and produce different results if they use different accounting assumptions.

That creates obvious seller risk where the earn-out depends on profit rather than a simpler metric such as gross revenue or units sold.

A buyer may have legitimate reasons to change accounting treatment after completion. It may integrate the company into a group, adopt group reporting policies or change provisioning practices.

But if those changes affect the earn-out calculation, the seller may receive less even though the underlying commercial performance has not deteriorated.

The SPA should therefore make clear which accounting policies govern the earn-out calculation and how changes in policy are treated for that purpose.

The biggest structural problem is control

After completion, the buyer usually owns the company.

That means the seller may depend on future performance while no longer controlling the decisions that produce that performance.

The buyer may change pricing. It may reduce marketing. It may invest heavily and depress short-term profit. It may move a major customer contract to another group company. It may replace management, close a division, combine the business with another operation or prioritise long-term growth over the metric used for the earn-out.

None of those decisions is automatically improper. The buyer purchased the company and will usually expect to manage it.

The seller's task is therefore to identify which buyer actions would make the earn-out commercially meaningless and negotiate targeted protections against those actions.

Do not rely on a vague promise to run the business "normally"

A broad obligation to operate in the ordinary course can sound reassuring but still leave room for disagreement.

If the seller's deferred value is highly sensitive to specific decisions, the drafting should address those decisions directly where commercially achievable.

Depending on the deal, the seller may want restrictions or adjustment mechanisms dealing with:

• diverting customers, revenue or opportunities to another group company;

• imposing new group management charges;

• changing accounting policies used for the calculation;

• disposing of a material business line;

• materially changing the nature of the business;

• entering non-arm's-length related-party arrangements; or

• taking identified actions mainly for the purpose of reducing the earn-out.

The appropriate level of protection depends on bargaining strength and the buyer's need for operational freedom. A seller should not expect to retain full control after selling the company. The aim is to protect the agreed price mechanism, not to prevent the buyer from owning the business it bought.

Information rights matter because the seller no longer sees everything

An earn-out dispute often starts with an information problem.

Before the sale, the seller can see the accounts, customer pipeline, management reports and operational decisions. After completion, that access may disappear.

If the buyer then produces a calculation showing the earn-out was missed, the seller needs enough information to understand and test that result.

The SPA should therefore deal with the seller's post-completion access to relevant accounts, working papers, management information and supporting records for the earn-out calculation.

It should also address timing. A right to information is less useful if the seller receives it only after the deadline for challenging the calculation has expired.

Plan for restructuring, acquisitions and disposals

The business may not look the same during the earn-out period as it did on completion day.

The buyer may acquire another company and combine operations. It may sell a division. It may transfer intellectual property or employees into another group entity. It may centralise sales, finance or technology functions.

Those changes can make the original earn-out metric difficult to apply.

A seller should therefore ask what happens if the structure changes in a way that makes the agreed performance measure no longer comparable.

The answer might be an adjustment formula, a deemed result, an acceleration mechanism or another agreed treatment. The right answer depends on the transaction, but silence creates avoidable dispute risk.

Keep employment and purchase price conceptually separate where that is the deal

Some sellers remain with the company after completion as directors, employees or consultants.

That can create a sensitive issue: should the seller lose the earn-out if that employment ends?

The answer depends on what the parties are actually buying and agreeing.

If the earn-out is genuinely part of the price for the shares, the seller should examine carefully any drafting that makes payment depend automatically on continued employment regardless of why the employment ends.

Conversely, if the commercial bargain assumes that the seller will personally drive the business during the earn-out period, continued involvement may be central to the formula.

The documents should say clearly how resignation, dismissal, illness, death, role changes or buyer-led termination affect the contingent price rather than leaving that question for a later dispute.

Be careful with set-off against deferred consideration

A buyer may want the right to deduct warranty, indemnity or other claims from money still owed to the seller.

From the buyer's perspective, that avoids paying money out while simultaneously pursuing a recovery claim.

From the seller's perspective, a broad set-off right can turn fixed deferred consideration into something much less certain.

The seller should ask:

• what types of claim can be set off;

• whether the claim must be admitted, finally determined or merely asserted;

• whether the buyer can hold back the whole deferred payment because of a smaller disputed claim;

• what happens to the withheld amount if the buyer's claim fails; and

• whether different rules apply to fixed deferred consideration and an earn-out.

This issue links directly to the seller's wider post-completion liability framework. See our guide to seller liability after a business sale for the broader treatment of caps, thresholds, claim periods and set-off risk.

Fixed deferred payments may justify security

If the buyer owes a fixed amount after completion, the seller is effectively giving value now and taking payment risk later.

The seller should consider what happens if the buyer's financial position changes before the deferred amount falls due.

Depending on the deal, the parties may consider security, guarantees, escrow, retention structures, acceleration on default or other payment protections.

The commercially important question is not whether a particular form of security is always necessary. It is whether the seller is comfortable becoming an unsecured creditor for part of the sale price after giving up control of the company.

What if the buyer resells the company before the earn-out ends?

A resale can create both opportunity and risk.

The buyer may sell the company, merge it into another group or undergo its own change of control before the earn-out measurement period ends.

The seller should know whether the earn-out continues unchanged, transfers to the new owner, accelerates, is calculated early or is replaced by another agreed amount.

This should be decided when the SPA is negotiated, not when a second transaction is already underway and the seller has little leverage.

Build the calculation and dispute process before there is a dispute

The SPA should explain who prepares the earn-out calculation, when it must be delivered and how long the seller has to review it.

It should also address what happens if the seller disagrees.

A workable process may include a written notice of disagreement, identification of disputed items, exchange of supporting information and referral of defined accounting disputes to an agreed independent expert or another dispute process.

The key is to separate genuine accounting disagreements from wider legal disputes about buyer conduct or contractual interpretation, which may require a different resolution mechanism.

A seller should not discover after completion that there is no practical route to test the buyer's calculation.

Model the downside before accepting contingent value

Before agreeing the structure, model at least three outcomes:

• base case: the business performs broadly as expected;

• downside case: performance is weaker or buyer decisions reduce the metric; and

• dispute case: the target is close, but the parties disagree on accounting or conduct.

Then ask what the seller receives under each scenario.

This exercise often exposes whether the "RM15 million deal" is really a RM10 million certain sale plus a highly speculative RM5 million upside.

Once that is visible, the seller can decide whether the risk is worth taking or whether more value should move into completion cash or fixed deferred consideration.

When should a seller push back on an earn-out?

An earn-out deserves particular caution when:

• the formula cannot be calculated objectively;

• the buyer controls key inputs but the seller has no conduct protections;

• the seller has no meaningful information rights;

• accounting policies can change freely;

• the buyer can divert business elsewhere in its group;

• continued employment is a hidden condition to receiving sale proceeds;

• broad set-off rights allow payment to be withheld on an unproven claim;

• there is no sensible treatment for restructuring or resale; or

• the dispute process is too slow or expensive relative to the amount at stake.

Sometimes the right answer is better drafting. Sometimes it is a shorter earn-out period, a simpler metric, a minimum guaranteed payment or more consideration paid at completion.

And sometimes the seller should recognise that the contingent headline value is not worth enough to bridge the valuation gap.

How the earn-out fits into the wider SPA negotiation

An earn-out should not be negotiated in isolation from the rest of the Share Sale and Purchase Agreement.

The payment structure interacts with warranties, indemnities, seller liability, set-off, continued management obligations, restrictive covenants and completion mechanics.

For the broader seller-side negotiation framework, see our guide to what a seller should negotiate in the SPA.

When should a seller get legal help?

Before the contingent price structure becomes commercially fixed.

Once a term sheet says "RM5 million earn-out based on EBITDA over two years", much of the economic bargain may already feel agreed. But the detail that determines whether the RM5 million is realistically payable may still be completely open.

Transaction counsel should help translate the headline structure into a measurable formula, buyer-conduct rules, information rights, payment protections and a dispute process that reflect the actual commercial deal.

Legal That Works assists Malaysian founders, shareholders and corporate groups on seller-side share transactions, including deferred consideration, earn-outs and the wider Share Sale and Purchase Agreement.

This article is for general information only and does not constitute legal advice. Every transaction and every set of facts is different. Obtain specific advice from a qualified adviser before acting on any part of it.

View our Share Sale and Purchase Agreement service if you are negotiating a business sale where part of the price will be paid after completion or depends on future performance.