THE Earn-out, In a literal translation, "earning over time" can be understood as "winning over time." In the context of mergers and acquisitions (M&A), the term designates a mechanism by which part of the price is linked to the achievement of future goals. In practical terms, a portion of the value will only be paid if the results defined in the contract are achieved after the closing of the transaction. This structure is adopted when there are uncertainties regarding the future performance of the company or disagreements between buyer and seller regarding the pricing of the business at the time of the transaction.

This mechanism is most frequently used in businesses where a large portion of the value is associated with intangible assets, such as intellectual property, software, or customer relationships, as well as in companies with accelerated growth or that operate in sectors marked by volatility or constant regulatory changes.

Empirical studies analyzing private company acquisition contracts indicate that clauses of Earn-out These are common in middle-market transactions. Private Target M&A Deal Points Study, published by the American Bar Association, and the Deal Terms Study Studies by SRS Acquiom, which examine hundreds of contracts entered into in different market cycles, show that earn-outs remain a relevant instrument for accommodating valuation discrepancies and distributing risk when future performance is still an open variable.

In these situations, the Earn-out It functions as an adjustment mechanism. The buyer pays part of the price upon closing and links another portion to the company's future performance. If the goals are met, the remaining amount is paid. Otherwise, it may be reduced proportionally to the result actually achieved or may even cease to be due.

In the contract, the wording of the clause of Earn-out It guides the allocation of risks between the parties and impacts the resolution of disputes; therefore, clear goals and objective calculation criteria are indispensable, and such measures can be decisive in resolving potential conflicts. Subjective goals, excessively discretionary criteria, or metrics subject to unilateral adjustments considerably increase the likelihood of disagreements.

Although there is still not a significant volume of judicial decisions on the subject in Brazil, the potential for controversy is evident when payment depends on future financial targets and the company's management is already under the control of the buyer.

This is where the tension becomes clear, given that, in most sale-of-control transactions, the seller ceases to exercise significant decision-making influence but remains economically exposed to the company's performance. Therefore, part of the price the seller expects to receive depends on results that are now driven by someone else.

After the closing, decisions regarding commercial policy, cost structure, investments, executive replacement, talent retention, allocation of expenses within the group, or even changes to the business plan, become the responsibility of the new controlling shareholder. These are legitimate business decisions, but they can directly affect the metrics that determine the payment of... Earn-out.

From a legal perspective, this asymmetry requires caution, so that the controlling party cannot act in a way that frustrates the fulfillment of the already established contractual condition. Even if the contract does not prevent strategic adjustments, the exercise of controlling power is limited by objective good faith and the prohibition against abuse of rights.

Therefore, the discussion cannot be limited to the interpretation of the clause. It is necessary to look at the design of the operation and question whether: Were governance mechanisms foreseen to reduce the misalignment between those who control the company and those who still depend economically on achieving the goals?

Shareholder or partner agreements are usually the main instrument for addressing this issue. They can provide for more robust information rights, qualified quorums for certain decisions, and restrictions on measures that directly impact company metrics. Earn-out, obligation to comply with the approved business plan or even the creation of specific committees to monitor the performance of the goals.

In other words, even when the buyer retains control, it is possible to structure safeguards that ensure the minority seller has some level of influence over decisions that could affect the agreed-upon indicators. This is not about unduly limiting control, but about preserving the economic balance of the transaction.

From a tax perspective, in M&A transactions, the taxation of Earn-out, In light of Tax Ruling No. 82/2023 and the administrative jurisprudence of the Administrative Council of Tax Appeals (CARF) and the Superior Chamber of Tax Appeals (CSRF), the application of capital gains tax depends on the legal nature of the payment. The Federal Revenue Service has consolidated its understanding that, when the variable portion is linked to the sale of the equity stake itself, even if conditional on future targets, it is included in the total value of the transaction for the purpose of calculating capital gains, and the tax must be adjusted as the installments become due. In this case, the Earn-out It forms part of the purchase/sale price and does not qualify as an operating expense.

On the other hand, administrative decisions demonstrate that if the variable portion is conditional upon the seller remaining in management, providing services, or fulfilling personal obligations in the post-closing period, the Tax Administration may reclassify the payment as remuneration or operating expense, applying the tax regime specific to operating income.

Thus, the determining factor is not the contractual issue, but the legal basis for the payment obligation, and it is essential that the contract makes it clear whether the Earn-out constitutes (i) a portion of the purchase price OR (ii) consideration for activities subsequent to the transaction. Depending on how it is classified, the value of Earn-out This can be revised over time, directly impacting the company's bottom line.

THE Earn-out, Therefore, it is not merely a technical pricing mechanism, but rather a risk allocation tool that demands contractual clarity and discipline in post-sale management.–Closure and transparency in communication to the market are crucial, as they alter the power dynamics within the operation and expose the seller to an additional period of risk. Accepting this mechanism means accepting that part of the price will depend on decisions that are often no longer under their control.

Before agreeing to an earn-out

Ask yourself who will decide about (i) investments; (ii) cost cuts; (iii) strategic hiring or changes to the business plan; (iv) the goals are objectively defined; and (v) the calculation criteria are verifiable and feasible. These issues, often treated as details, can determine the success or failure of an operation.

Ask which governance instruments are in place. They guarantee access to information and some influence over decisions that can directly affect the goals.

Ask if the tax and corporate structure It was designed to avoid unexpected upgrades and distortions.

Selling control is a strategic decision., Therefore, linking a significant portion of the price to the future requires the same level of rigor. The time to structure your protection is during trading. After the close, the room for adjustment is significantly smaller, and the question remains: If the outcome is not as expected, does your contract offer clear answers or does it leave room for dispute?

If your transaction involves earn-outs or performance-based pricing mechanisms, it's worth carefully evaluating the contractual structure, post-closing governance, and tax implications. Our team remains available to discuss this topic and support you in structuring these clauses in M&A transactions.

Article written by: Antonio Mazzucco, Ricardo Alegransi, Marina Moreno, Henrique Melo and Piao Min You.