Contingent consideration and non-cash consideration are increasingly popular mechanisms both for closing deals, bridging a gap in price expectations, and addressing potential risks in post-deal performance.

Corporate Finance Insights Bridging the Value Gap

Contingent consideration can take many different forms:

  • An earn-out is the most common form where a portion of the purchase price is conditional on future events, usually the financial performance of the business.
  • Retention or holdback can be described as a portion of the purchase price that is not paid at the completion date to protect the buyer against potential post-deal liabilities. These may be held in an escrow account and can arise to cover:
    • Potential normalised working capital adjustments; or
    • Outstanding litigation; or
    • Pension deficits; or
    • Warranty and indemnity claims

For the purchaser, contingent consideration must be measured at fair value to determine the acquired goodwill. The valuation of earn-outs presents the following challenges:

  • The inherent difficulty to project the timing and occurrence of future events
  • The difficulty of determining the outcome of future events
  • The selection or estimation of performance target achievement probabilities
  • The selection of an appropriate discount rate

An earn-out is deferred consideration dependent upon the future performance of the business being acquired. The principal purpose is to bridge the price expectation gap between the buyer who will pay a price on past profits and the seller who expects a price based on the future potential of the business.

The difficulty for earn-outs is balancing the needs of a vendor to run the business and the purchaser to control it. The vendor needs to retain control, the purchaser needs to be involved in shareholder issues – new investments.

Features of earn-outs:

  • Often based on EBITDA or pre-tax profits
  • Can often be based on averages of profits for two or more periods
  • Often paid between 2 and 4 years
  • Targets are often set in proportional bands, rather than a cliff edge and increase in value as profit or EBITDA grows to incentivise all parties, for example, EBITDA >£a multiplied by x, EBITDA >£b multiplied by y
Buyer Seller Seller
Advantages Disadvantages Advantages Disadvantages
Lower initial consideration;

A pool to offset warranty & indemnity claims;

Motivated seller with continued commitment;

The maximum cost is known (if capped);

Secures non-competition

Harder to integrate;

Difficult to motivate past management;

Cash generated is often insufficient to meet earn-out consideration;

Need to ensure funding availability at the end of the period;

Seller may insist on reverse due diligence to provide comfort on the ability of the acquirer to pay the earn-out

Higher overall price;

Employees can benefit;

Retain ‘directorship’ (but needs protection in the employment contract)

Risk of not receiving the full price;

Profit or calculation disputes, or working capital issues;

Not a full clean exit;

The tax treatment of the earn-out requires careful consideration;

Payment is dependent on the financial strength of the acquirer

Practical considerations:

  • Accounting policies to be adopted and used to calculate the earn-out
  • Impact of the acquisition on business performance
  • Who can hire and fire staff

Contingent consideration or non-cash consideration is also a mechanism for using the vendor as a source of acquisition finance.

The most common other forms of non-cash consideration are:

  • Ordinary shares
  • Unsecured loan notes
  • Ordinary shares in the original target company, acquirer company, or an intermediate company

Determining the value of a share exchange is particularly intricate where both the buyer and vendor are private companies. As a result, it becomes a relative valuation exercise between the buyer and the vendor.

Additional valuation considerations arise when a share exchange between companies represents controlling and/or minority interests. In the absence of a shareholder agreement that specifies shareholder rights, a minority position may be worth less than its pro-rata portion of the private company value.

The target’s assets can also be utilised to provide funding

  • Property sale and leaseback deals; or
  • Invoice discounting and stock financing of working capital; or
  • Simply the disposal of surplus assets including subsidiaries


If you would like to learn more about how member firms of Pandea Global M&A can support your business, or if you are an advisory practice interested in joining the network, please contact Callum and Connor.


Callum Sellar
E: [email protected]


Connor Monaghan
E: [email protected]