Forms of contingent consideration
Contingent consideration covers any payment that is conditional rather than fixed. The common forms are:
- Earnouts tied to revenue, gross profit, EBITDA or customer metrics over one to four years
- Milestone payments on events such as a product launch, regulatory approval or a key contract renewal
- Escrow or holdback releases conditional on no warranty claims
- Price adjustments linked to the outcome of a known dispute or tax matter
How it is accounted for
Under both IFRS 3 and ASC 805, the buyer recognises contingent consideration at its acquisition-date fair value as part of the purchase price. Where it is classified as a liability, which is usual for cash earnouts, it is remeasured at fair value each reporting period with changes going through the income statement. Where it is classified as equity, it is not remeasured.
Payments that depend on the seller staying employed are generally treated as post-combination compensation rather than purchase price, which changes the buyer’s reported earnings and can change the seller’s tax position.
Tax points for sellers
The tax treatment of deferred and contingent consideration varies sharply by jurisdiction and by whether payment is in cash, shares or loan notes. In the UK, the right to a future earnout can itself be treated as an asset for capital gains purposes, following Marren v Ingles. In the US, sellers may be able to report gain on the instalment method for contingent payments.
Because the outcome depends on structure, sellers should take tax advice before the letter of intent is signed, when the form of consideration is still open.
How sellers protect contingent value
Once the deal completes, the buyer controls the levers that decide whether targets are met. Protection has to be written into the agreement:
- Precise metric definitions, including accounting policies frozen at completion
- Operating covenants that stop the buyer starving or restructuring the business
- Acceleration of unpaid amounts on a change of control or a breach
- Information and audit rights, with an independent expert to settle disputes
- Catch-up provisions, so a missed year can be recovered by later outperformance
Frequently asked questions
- Is an earnout the same as deferred consideration?
- No. Deferred consideration is a fixed amount paid later. Contingent consideration, including an earnout, may never be paid if the condition is not met.
- How much of a price is usually contingent?
- It varies widely with the valuation gap and sector. Where contingent amounts are a large share of the price, the headline figure is a poor guide to what the seller will actually receive.
- How should a seller value an earnout?
- Probability-weight the scenarios and discount future payments at a rate that reflects the risk of non-payment. The earnout modelling tool does this across downside, base and upside cases.
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