Earn outs are the scary term in M&A that no one (other than maybe some buyers) love to see as part of the transaction structure in a deal. I've seen clients back out of deals that have otherwise achievable earn outs simply because the term was involved. There is a large degree of misunderstanding and fear, and that fear extends beyond founders and business owners to M&A professionals and investment bankers who should know better. Sometimes I feel like Harry Potter getting sssshed for bringing up the name Voldemort, as people don't want to even mention an earn-out for fear of it materializing in their deal.

The reality is that earn-outs are not always scary.

Contingent structures. That is the actual phrasing for an earn-out and I prefer it. Why? Because the term contingent structure has negative connotations and can be misleading about what they actually mean for sellers. And yes, some contingent structures do reflect the literal reality of earning part of your payment from the sale of your business. But in practice they are typically far more nuanced, often less frightening and sometimes quite lucrative for the seller.

Over the years, we have advised on transactions where sellers walked away from fundamentally strong deals because they feared earn-outs to the point of being unwilling to consider the rationale or necessity behind them. We have completed deals where sellers refused to push the transaction value higher via the utilization of a contingent structure, which would have made an already strong deal even stronger. That is an expensive form of fear. Contingent structures can be a powerful tool for aligning buyer and seller risk within a transaction. And conversely, they can be worth only the paper they are written on. The difference between those two outcomes is what this article is about.

This is the deep dive from a structural and psychological perspective surrounding all things contingent structure (contingent structures) that I have not seen written anywhere else.

Why Contingent Structure (Earn-outs) Exist At All

Before getting into the types, it helps to understand the job a contingent structure is actually doing in a deal. At its core, a contingent structure exists because a buyer and a seller cannot agree on value. The seller believes the business is worth $20M. The buyer believes it is worth $15M. Rather than walk away, they bridge the gap. The buyer pays $15M at close and the remaining $5M becomes contingent on future performance. If the business does what the seller says it will, the seller gets paid. If it doesn't, the buyer is protected.

That framing matters because it changes how you read a contingent structure when one appears in your deal. It is not a punishment. It is not a signal that the buyer thinks you have been dishonest. It is a mechanism for two parties who see the future differently to still get a transaction done. For context, contingent structures appear in roughly 30% of private M&A deals, with higher prevalence in transactions under $250M, which is precisely the segment of the market where valuation disagreements are most acute and buyer capital most constrained.

Contingent structures also appear for reasons well beyond the valuation gap. Sometimes a buyer's capital is constrained and they need to defer part of the consideration, funding it from the business's own future cash flows. This is particularly common in smaller transactions where leverage is tighter and deal economics require more creative structuring. Sometimes the seller's continued involvement is so central to the business that the buyer wants their economic interest aligned post-close. And sometimes there is genuine uncertainty in the business, whether that is a lumpy revenue profile, a key customer who may or may not renew, a product issue or a market event on the horizon, and the contingent structure is how both parties share that risk rather than fight over it in the price. That last point has become increasingly relevant as founders and buyers navigate a more complex and unpredictable operating environment than any of us anticipated a few years ago.

The Different Types of Contingent structures

This is where most articles stop at a surface level. There are actually several distinct contingent structures and understanding which type is sitting in front of you changes everything about how you evaluate and negotiate it.

All-or-Nothing (Milestone-Based)

This is the binary version and the one that deserves most of the fear that contingent structures generally attract. The seller must achieve a specific, pre-defined event in order to receive payment: a major contract signed, a regulatory approval, a product launch, a revenue threshold crossed. Hit it, you get paid. Miss it, you don't.

The key to a well-structured milestone contingent structure is that the triggering event should either be fully outside both parties' control, or so strategically important to the buyer that they are motivated to help it happen regardless of the payment obligation. Where these structures collapse is when the milestone requires buyer cooperation to achieve and that cooperation is never explicitly required in the agreement. Be very specific about what satisfies the milestone and make sure your agreement includes concrete examples of what will and will not qualify. Vague industry shorthand in a milestone definition is where disputes are born and where legal fees accumulate.

Aspirational (Tiered or Ladder)

These contingent structures are designed to reward the seller for performance that exceeds what is already visible in the business at the time of signing. Think of a significant contract on the horizon that has not been signed yet, a major new client in late-stage conversations during due diligence, or a market expansion that both parties believe is coming but neither wants to price at full value today.

The tiered structure introduces multiple performance bands. The seller receives a base payment for hitting the core target and progressively higher payments as performance climbs beyond it. A seller who genuinely believes in the upside of their business should pay close attention here, because a well-negotiated tiered structure can ultimately be more lucrative than a higher fixed price. You are essentially being given the opportunity to earn into your own optimism, on terms the buyer has already agreed to at the table.

Risk Mitigation (Straight-Line or Linear)

These are the buyer's downside protection structures and they are the most common contingent structure type in mid-market M&A. They appear when the business has a sporadic EBITDA history, when there is external uncertainty that could financially impact results, or when the buyer simply needs some performance confirmation before releasing the full consideration.

In a straight-line structure, the contingent structure payment is calculated as a percentage of a financial metric, most commonly revenue or EBITDA, over a fixed period of typically two to three years, paid on a pro rata basis each year. These are the least structurally complex contingent structures and when properly drafted around clear accounting policies and auditable metrics they are the most straightforward to administer. The danger is in the metric definition itself. EBITDA, for all its usefulness as a valuation anchor, is the most dispute-prone metric precisely because it can be moved by post-close decisions the buyer makes, including overhead allocations, capital expenditure timing and integration costs. Revenue is harder to manipulate and is often the cleaner choice.

Risk mitigation contingent structures also need to be handled cautiously by sellers for a reason that goes beyond the mechanics. They are a signal to the buyer of the confidence a seller actually has in their own ability to deliver. We recently ran a process where a client had averaged $4M in EBITDA annually but experienced a significant lag in the year we were marketing the business. Every buyer required an contingent structure tied to performance, and the hurdle for payout was set 25% below prior years' performance. Our client declined to proceed. They felt the pressure of managing through an contingent structure period was not worth it, which is a legitimate conclusion to reach. But it was also a signal to every buyer in the room that the seller lacked confidence in their own financial performance, and in M&A, how a seller responds to a contingent structure is often as telling as the financial statements themselves.

Fixed Percentage

A simpler variation: the contingent structure payment is a fixed percentage of a single metric, nothing more. No tiers, no sliding scale, no interpolation. These structures trade upside potential for predictability and for a seller who values certainty over optionality they can be genuinely attractive. The discipline here is keeping the metric simple and auditable from the outset.

Ratchet

Less common in North America but more heavily utilized in European and UK transactions, ratchet structures tie seller compensation to performance metrics in a way that can move materially in either direction. The concept is similar to a milestone-based contingent structure but with the added dimension that the payout ratchets both up and down depending on where performance lands against a range of thresholds. Before agreeing to one, a seller needs to understand clearly and honestly which direction the ratchet is most likely to move.

Equity Rollover

This one sits in a different category psychologically, even if it functions as a contingent structure in practice. Rather than receiving a deferred cash payment, the seller retains an equity stake in the business post-close, structured as subordinated equity, equivalent units, or shares that vest against performance or time-based conditions. The seller is no longer a vendor waiting on a payment. They become a co-investor in the new entity.

Equity rollover structures are most common in private equity platform deals and larger add-on acquisitions. For a seller who genuinely believes in what the combined business will become under new ownership, this can be a meaningful wealth creation event beyond what the original sale price ever captured. For a seller who wants a clean exit, it is the wrong structure entirely and that preference needs to be on the table early in the conversation, well before the deal gets built around an assumption that cuts against what you actually want.

Where Contingent Structures Go Wrong

Understanding the types is only half the picture. The other half is understanding why contingent structures fail, because many do, and not always for the reasons sellers expect.

The most important thing a seller needs to understand is this: once you close, the buyer runs the business. The buyer making entirely reasonable operational decisions, integrating your team, reallocating overhead, investing in new systems, can move the financial metrics you are being paid against in ways that have nothing to do with your business's underlying performance. This is not necessarily bad faith. Rather, it is the structural tension that lives inside every contingent structure and it is why governance provisions matter as much as the metric itself.

The most common dispute triggers are ambiguous metric definitions, post-close accounting policy changes and integration decisions that shift revenues or costs between entities. It is worth noting that legal filings mentioning contingent structure disputes doubled between the first quarter of 2022 and the first quarter of 2023, which is a reflection of how much can go wrong in the administration of what looks like a clean structure on paper. And is equally relevant given these spike in court proceedings were likely from deals consummated over the Covid-19 crisis where earn-outs were widely used to bridge valuation gaps due market related confidence. A buyer who already owns other businesses during your contingent structure period can route customers, expenses and intercompany charges in ways that affect your numbers, sometimes deliberately, but often simply because they are running a larger organization with different priorities than the one you built. Tight contract language, regular reporting requirements, seller audit rights and a fast-track dispute resolution mechanism are not negotiating flourishes. They are the difference between collecting your contingent structure and spending years litigating over it.

There is also a psychological dimension worth naming directly. Buyers often propose contingent structures because they do not fully trust the seller's projections or financials. That is not an insult. It is a logical response to the information asymmetry that is inherent in mid-market M&A. The seller knows their business better than any buyer ever will at the point of signing. A contingent structure is the buyer's way of saying: prove it with results rather than with forecasts. The sellers who navigate contingent structures most successfully are the ones who internalize that framing and approach the contingent structure period as a performance opportunity rather than a creditor relationship. That mindset shift is not a small thing.

How to Negotiate One You Can Actually Win

If a contingent structure is going to be part of your deal, here is where to focus your energy.

Choose the right metric. Revenue is more reliable and harder to manipulate than EBITDA. EBITDA aligns more closely with value but requires an agreed-upon set of accounting policies, documented add-backs, clearly defined attributable costs and fixed capitalization thresholds to be defensible. We worked on a transaction where, in the first year after closing, the buyer quadrupled the marketing expenses allocated to the acquired business and created a significant dip in EBITDA that became a serious contingent structure problem for our client. Whatever metric you agree to, attach concrete examples of what is and is not included in the calculation. Ambiguity here is expensive in every sense of the word.

Lock accounting policies at signing. The contingent structure metric should be calculated using the same accounting policies that governed your quality of earnings process. If those policies can shift post-close, your metric shifts with them and typically not in your favour.

Negotiate reporting rights. You should receive regular financial statements covering the contingent structure metric with enough detail to verify the calculation independently. There needs to be a defined objection window and a fast-track accounting arbitration mechanism if disputes arise. These are standard asks in any well-structured transaction. A buyer who resists them is telling you something worth paying attention to.

Get covenants on business conduct. The buyer should be contractually restricted from taking actions that would deliberately impair contingent structure metrics, whether that is asset stripping, diverting key customers or deferring revenue recognition outside your contingent structure window. These covenants will not prevent every form of metric interference but they create legal recourse if it happens and they establish the right tone for the relationship going forward.

Understand your transaction dependency. Before accepting any contingent structure, be honest with yourself about what percentage of your total consideration is contingent. A contingent structure that represents 10% of deal value is frosting on an otherwise complete transaction. Conversely, a contingent structure that represents 40% of deal value is a fundamentally different negotiation and should be treated accordingly. It is also worth understanding that contingent structures can be a powerful tool for negotiating total deal value higher. Positioned correctly, they do not necessarily cost the buyer anything additional in the near term, which means they can create a mechanism for extracting more total consideration than a fixed price negotiation would have allowed.

Contingent structures, properly understood, are not the enemy of a good deal. They are a structural tool that exists because value is genuinely debatable and the future is genuinely uncertain. The sellers who walk away from contingent structures out of fear often leave real money behind. The sellers who accept them without understanding the mechanics often never collect what they were promised. Neither outcome is necessary. The difference, almost always, is in the preparation.

Reece Tomlinson is the Founder and CEO of RWT Capital Corp., a boutique mid-market M&A advisory firm. Uncommon Capital is her newsletter on mid-market transactions and the nuances that make or break deals.