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February 14, 2024

Determination Of The Share Transfer Price Through Earn-out Mechanism


The determination of the purchase price stands as a central point of contention during negotiations in merger and acquisition (“M&A”) transactions. Particularly in cross-border contexts, buyers may seek to mitigate risks by exploring alternative payment methods. One such method is the utilization of “earn-out” clauses, wherein a portion of the purchase price is contingent upon the future financial performance of the target company. Statistics from 2023 reveal that earn-out clauses were integrated into approximately 30% of acquisitions in the United States. Similarly, earn-out provisions are prevalent in share purchase agreements across Europe, notably in transactions involving start-up enterprises. This prevalence is accentuated in scenarios where uncertainties regarding the target company’s future performance are heightened, and the buyer lacks comprehensive market experience.


An “earnout” represents a contractual clause utilized in M&A transactions to delineate the conditions under which a buyer commits to disbursing additional compensation to the seller following the closing of the deal. This additional compensation is contingent upon the attainment of predetermined performance benchmarks by the acquired business post-closure, or upon the materialization of specified events. 

In the first type of earn-out clauses, the purchaser commits to paying the seller an initial portion of the purchase price, known as the base price, which is determined based on the “current value” of the target enterprise as of the closing date. Subsequently, upon the conclusion of a specified earn-out reference period, the purchaser disburses a second portion of the purchase price to the seller. This second portion is calculated based on the “future value” of the target, contingent upon the target achieving predetermined financial milestones within the reference period. This structure represents the most prevalent form of earn-out clauses in transactions.

In the second type of earn-out clauses, the purchaser gradually acquires all the shares of the target company through successive tranches. Consequently, the purchaser makes multiple payments corresponding to the number of agreed-upon tranches of shares outlined in the transaction. The purchase price for the initial tranche of shares, determined based on the “current value” of the target, is definitive.

Subsequent payments for additional tranches of shares are contingent upon the target achieving one or more financial milestones during one or more successive post-closing earn-out reference periods. Additionally, parties often stipulate a minimum or maximum amount for each successive earn-out to mitigate excessive fluctuations in the aggregate purchase price. This structure provides a framework for gradual acquisition and aligns payment with the target’s performance over successive periods.


This mechanism is particularly advantageous when there exists disparity between the buyer’s and seller’s assessments of the business’s value, often stemming from divergent estimations of future business performance or the likelihood of certain future events relevant to the acquired business.

Earnouts are widely employed in various scenarios. Firstly, they are deployed when the seller is slated to remain engaged in the business following the transaction’s closing, with the earnout serving as an incentive for the seller to sustain or enhance the business’s profitability for the buyer’s benefit. Secondly, they are utilized when the acquired entity possesses limited operational history but holds substantial potential for growth consequent to the M&A transaction. Thirdly, earnouts come into play when the acquired business gains access to new technology, potentially augmenting its profitability or overall value. Furthermore, they are implemented when the acquired company encounters a preceding downturn in earnings, which the seller believes to be temporary. Lastly, earnouts are commonly utilized when the acquired business operates within a volatile economic or industry landscape, wherein its profitability or value is susceptible to significant fluctuations.


Earn-out clauses should be meticulously crafted to mitigate potential conflicts of interest and establish equilibrium between involved parties. A crucial aspect in ensuring a fair earn-out claim lies in the accurate calculation of the target company’s objective financial metrics. These metrics encompass various budgetary targets such as cash flow, balance sheet income, gross or distributable profit, annual turnover, EBIT (earnings before interest and taxes), and EBITDA (earnings before interest, taxes, depreciation, and amortization).

However, reliance solely on calculation formulas may not accurately depict the target company’s true financial position. Consequently, buyers often opt to establish turnover targets instead of relying solely on predetermined financial metrics. Among these, EBITDA holds particular favor as it offers less room for manipulation of costs by the buyer.

Moreover, non-financial parameters may also be incorporated to determine future payment of the purchase price. Generally, non-financial events serve as a basis for acquisitions involving startups or companies operating within regulated sectors. Examples include conditions related to the seller’s continued involvement in company management post-closure or the acquisition of necessary official approvals. 


Although the concept of an earn-out mechanism is not expressly regulated in our legislation, the stipulation of linking the payment of a portion of the purchase price to the occurrence of certain financial or non-financial conditions in the future aligns with the provision of suspensive conditions regulated under Article 170 of the Turkish Code of Obligations Law No: 6098 (“TCO”). In essence, the condition for the payment of a portion of the purchase price becoming due is left to future occurrences that are likely to take place. In this context, the provisions of the TCO regarding the suspensive conditions and, to the extent appropriate, the provisions regarding sales and proxy agreements shall apply to potential disputes.


While earnouts serve as a mechanism to resolve disagreements arising during purchase price negotiations, they often lead to disputes post-closure regarding earnout calculations, which can escalate to litigation, arbitration, or mediation. To mitigate the risk of such issues, it is essential for both buyer and seller to negotiate and agree upon specific provisions and procedures tailored to the transaction context, covering earnout calculation, parties’ respective earnout-related obligations, and mechanisms for disputing earnout calculations.

These disputes can be prevented or mitigated through careful drafting and negotiation of the earnout clauses. However, this process is complex and may require additional time and cost from the legal team. Additionally, intricate earnout provisions may necessitate substantial accounting and financial statement analysis, typically involving external accounting and financial teams.


In summary, “earn-out” payments are contractual tools used in M&A transactions to provide additional compensation to sellers based on the acquired business’s future performance..Earn-out clauses help bridge to close gaps in the target company’s valuation , encourage seller participation in the target company’s growth, and adapt to diverse business scenarios. Including earn-out provisions, both based on financial performance indicators or non-financal performance indicators, in share purchase agreements shall help to reduce the risk of future disputes between parties. However, it should be noted that while earn-out provisions may help to resolve disputes regarding the determination of the share purchase price, earn-out clauses drafted without comprehensive negotiation and without undergoing legal and financial analysis shall also lead to post-closing disputes.


Sevinç Jafarova

Sevinç Jafarova


Erkin Can Ortaş

Erkin Can Ortaş

Legal Intern

Oğuzcan Dozcan

Oğuzcan Dozcan

Senior Associate