Tax Implications of Earn outs

When planning the sale of a business, the tax implications should never be overlooked. With careful planning and advice, maximum value can be extracted from the sale. Often, however, hard-earned gains unnecessarily slip through the vendor's fingers into the coffers of the Inland Revenue.

For anyone not familiar with the term, an 'earn out' will often occur when a business is sold and there is difficulty in agreeing a value fair to both vendor and purchaser. In such circumstances, an earn-out represents further consideration for the purchase of the business. Typically, the vendor will receive a cash sum, or an initial issue of securities, plus an earn out consisting of one of the following:

A right to receive loan notes (issued by the purchaser) after a certain period has elapsed and dependent on the performance of the newly taken-over business. The loan notes would be redeemable after a certain period or periods.

A right to receive securities in the purchaser or its parent company after a certain period has elapsed and dependent on the performance of the newly taken-over business. These may or may not have restrictions placed on them.

Restricted (forfeitable) securities (shares or loan notes) issued by the purchaser and which vest after certain performance targets have been reached.
Convertible securities, issued by the purchaser and which convert into a more valuable security after certain performance targets have been reached.

As well as representing "further consideration", an attraction of earn outs is that they allow for...

Other areas covered:

Inland Revenue guidance

How to structure and earn out to avoid tax

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