Earn-out Agreements in New Zealand Business Sales

An earn out agreement can help bridge the gap when a buyer and seller disagree on what a business is worth, but it can also become the most disputed part of the deal if it is drafted loosely. Founders often make three avoidable mistakes: relying on vague performance targets, failing to control how the buyer will run the business after settlement, and assuming everyone means the same thing by terms like revenue, profit, or completion. Those issues usually surface after the sale, when the seller no longer controls the business and the buyer is focused on integration.

If you are buying or selling a New Zealand business, the key question is not just whether an earn out sounds fair. The real question is whether the formula, timing, reporting, and conduct rules are precise enough to be enforceable and commercially workable. This guide explains what an earn out agreement means, the legal issues to check before you sign, the mistakes that regularly trigger disputes, and the points that should be nailed down in the sale documents.

Overview

An earn out agreement is a contractual mechanism where part of the purchase price is paid later if the business hits agreed targets after settlement. It is often used when the seller believes the business has strong upside and the buyer wants protection against overpaying. In New Zealand business sales, an earn out usually sits inside the main sale and purchase agreement or as a detailed schedule to it.

• Define the earn out formula precisely, including whether targets are based on revenue, gross profit, EBITDA, customer numbers, retention, or milestones.
• State the earn out period, payment dates, accounting methods, and who prepares the calculations.
• Set rules for how the buyer can operate the business during the earn out period, especially where business decisions could affect results.
• Deal with access to records, dispute resolution, and the seller's right to review or challenge calculations.
• Cover what happens if the business is merged, restructured, sold again, or materially changed before the earn out is finalised.
• Check restraint, employment, consultancy, and handover terms if the seller will stay involved after settlement.

What Earn Out Agreement Means For New Zealand Businesses

An earn out agreement shifts part of the pricing risk from settlement day into the future. That can make a business sale possible where the parties cannot agree on valuation, especially for founder-led businesses, service businesses, agencies, technology businesses, and companies with recent growth that has not yet settled into a long trading history.

In simple terms, the buyer pays one amount upfront and agrees to pay more later if the business performs in a specified way. The seller accepts that some of the purchase price is contingent, rather than guaranteed.

Why buyers and sellers use earn outs

Earn outs are common where there is uncertainty about future performance. A seller may feel the latest contracts, customer pipeline, or expansion plans justify a higher price. A buyer may be concerned that those forecasts are not yet proven or that performance depends heavily on the current owner staying involved.

An earn out can help in situations such as:

• a business with strong recent growth but limited historic financials
• a founder-led business where customer relationships sit heavily with the seller
• a business affected by unusual one-off trading conditions
• a business with upcoming contracts or product rollouts that may increase value
• a sale where the buyer wants to align part of the price with actual post-sale results

What an earn out usually measures

The most important commercial issue is the target used to trigger payment. The wrong metric can create arguments even where both sides acted honestly.

Common metrics include:

• revenue over a set period
• gross profit or net profit
• EBITDA or another earnings measure
• customer retention rates
• number of signed customers or users
• completion of milestones, such as product development, regulatory approvals, or rollout benchmarks

Each metric has different risks. Revenue may be easier to measure, but it can ignore discounting, bad debt, or expensive customer acquisition. Profit-based measures can better reflect real value, but they are more vulnerable to accounting treatment, cost allocation, management charges, or changes in business strategy.

Where New Zealand sale documents matter most

In New Zealand, the earn out is generally governed by ordinary contract law principles and the wording of the sale documents. That means precision matters. If a term is vague, a court or arbitrator may struggle to fill in the gaps in a way either side likes.

The earn out provisions often sit alongside other sale terms, including:

• warranties about the business and its financial information
• indemnities for specific risks
• restraint clauses stopping the seller from competing
• employment or consultancy arrangements if the seller stays on
• handover obligations for systems, clients, suppliers, and know-how
• adjustment mechanisms for stock, debtors, cash, or working capital at settlement

These parts of the deal affect each other. For example, if the seller is required to help retain clients for 12 months, the earn out targets and the seller's role need to line up. If they do not, the seller may be blamed for poor performance without having any real control over outcomes.

Legal Issues To Check Before You Sign

The legal strength of an earn out agreement depends on the detail. Before you sign a contract, the main job is to remove uncertainty about calculation, control, information, and what happens if the business changes shape after settlement.

1. The trigger for payment

The agreement should say exactly what must happen before the buyer owes the additional amount. Avoid loose phrases like “strong performance” or “meeting budget”.

The document should clearly cover:

• the metric being measured
• the period for measurement
• the accounting standards, policies, and assumptions used
• whether the target is a minimum threshold, a sliding scale, or an all-or-nothing test
• any exclusions, such as one-off costs, extraordinary items, or owner-related expenses

If profit is the metric, define how overheads are allocated. This is where founders often get caught. A buyer may centralise admin, add management fees, or invest heavily in growth, which can reduce the reported profit even if the business is performing well commercially.

2. Control of the business during the earn out period

If the seller's payment depends on future performance, the buyer's post-settlement decisions matter. The agreement should address what freedom the buyer has to run the business as it chooses and what restrictions apply so the earn out is not undermined.

Possible protections include:

• a promise to operate the business in good faith toward the earn out calculation
• a requirement to maintain separate accounts for the business unit
• limits on diverting customers, staff, or revenue to related entities
• restrictions on changing pricing, sales channels, or key expenditure categories without notice
• rules about merging the business into another operation

Buyers usually resist broad operational restrictions, and that is understandable. They want freedom to integrate the acquisition. The solution is usually a tailored clause that targets the real risks rather than trying to freeze the whole business.

3. Access to records and verification rights

The seller should not have to rely on a short email saying the target was missed. The agreement should set out what information the buyer must provide and when.

This often includes:

• periodic management accounts or performance reports
• notice of the buyer's earn out calculation by a fixed date
• access to supporting records on reasonable notice
• a right for the seller or its adviser to review the calculation
• a timetable for raising objections

Without those rights, a seller may have difficulty testing whether the numbers are accurate.

4. Dispute resolution

Earn out disputes often turn on accounting questions, mixed with legal interpretation issues. The agreement should say how disputes are handled and whether an independent accountant, expert, mediator, or arbitrator will be involved.

The clause should deal with:

• what types of issues go to expert determination and what types remain legal disputes
• how the expert is appointed
• whether the expert acts as an expert or as an arbitrator
• who pays the expert's costs
• whether the undisputed part of the earn out must still be paid on time

Those details matter because the process can affect cost, speed, and enforceability.

5. Seller involvement after settlement

If the seller is expected to stay on to support the business, the sale documents should separate the seller's role as employee or consultant from the buyer's payment obligations under the earn out. If those concepts are blurred, termination rights and other disputes can spill into pricing disputes.

Check points such as:

• job title, duties, reporting lines, and hours
• how long the seller stays involved
• base salary or consultancy fees, separate from earn out payments
• what happens if the seller resigns, is dismissed, becomes unwell, or is sidelined
• whether bad leaver style consequences apply, and if so, in what limited circumstances

Employment law issues may also arise if the seller becomes an employee. Those should be documented carefully and handled separately from the sale price mechanics.

6. Business changes during the earn out period

The agreement should say what happens if the acquired business is not operated in the same stand-alone way after settlement. This is especially important where the buyer plans to integrate systems, merge entities, or sell part of the business again.

Before you rely on a verbal promise that “we will keep things separate”, get the contract to cover scenarios such as:

• restructuring or rebranding the business
• transferring contracts to another group company
• selling some or all of the business to a third party
• changing the accounting period
• discontinuing a key product or service line

If those events occur, the contract may need a deemed calculation method or accelerated payment rule.

7. Tax and structuring issues

The legal documents should also describe the character of the earn out payment and how it fits within the broader transaction structure. You should speak with an accountant or tax adviser on tax treatment, because the answer depends on the deal structure and the parties' circumstances.

From a legal drafting perspective, it helps to clarify:

• whether the earn out forms part of the purchase price for shares or assets
• when the payment obligation legally arises
• whether any security is provided for deferred payment
• whether there is a set-off right against warranty or indemnity claims

These points affect risk allocation between buyer and seller.

Common Mistakes With Earn Out Agreement

Most earn out disputes do not happen because one side planned to act unfairly. They happen because the documents left too much room for different expectations. The common mistakes below are the ones most likely to cause trouble after settlement.

Using vague financial definitions

The phrase “net profit” looks simple until the parties disagree about depreciation, owner expenses, related-party charges, or one-off integration costs. If the formula can be interpreted in more than one reasonable way, it probably will be.

A better approach is to define the relevant metric in the agreement itself, with worked examples if the formula is complex.

Ignoring buyer control over results

A seller may accept a lower upfront price because it expects to hit the earn out. But once settlement occurs, the buyer controls staffing, marketing spend, pricing, product mix, and integration decisions. If the contract says nothing about conduct during the earn out period, the seller carries a lot of hidden risk.

This does not mean the buyer should lose operational freedom. It means the agreement should deal honestly with decisions that could artificially depress or redirect the measured result.

Tying the earn out too closely to the seller's employment

Some deals say the seller loses the earn out if they are no longer employed at payment time. That can be commercially harsh and legally risky if the seller is removed for reasons unrelated to business performance.

If continued involvement is genuinely important, draft that carefully. The clause should distinguish between resignation without good reason, serious misconduct, and termination initiated by the buyer.

Failing to set a clear timetable

An earn out should not drift. If the agreement does not specify when accounts are prepared, when calculations are issued, when objections must be made, and when payment falls due, delay itself becomes a dispute.

Set dates or clear calculation periods. Certainty reduces friction.

Leaving dispute mechanics until later

Parties sometimes assume they will sort out any disagreement commercially if it arises. That assumption often breaks down once money is on the line.

A practical dispute clause should identify the decision-maker, the process, and the effect of the outcome. It should also avoid forcing every accounting issue into full court proceedings.

Overcomplicating the formula

An earn out can be too clever for its own good. Multi-step formulas with adjustments, caps, floors, exceptions, and subjective conditions can become hard to administer.

If the business rationale can be captured in a simpler way, that is usually better. Simplicity lowers the risk of future argument.

Not aligning the earn out with the rest of the sale documents

The earn out sits inside a broader transaction. Problems arise where one clause says the seller must assist transition for six months, another restrains the seller from contacting customers, and a third assumes the seller will maintain customer relationships to help hit the target.

Read the whole deal together, including:

• the sale and purchase agreement
• disclosure materials
• warranty and indemnity clauses
• employment or consultancy documents
• restraint provisions
• security documents for deferred amounts

If these pieces pull in different directions, the earn out can become unworkable.

FAQs

Is an earn out agreement legally enforceable in New Zealand?

Yes, if it is properly drafted as part of a binding sale arrangement. The main issue is usually not enforceability in theory, but whether the payment formula and conduct obligations are clear enough to apply in practice.

Should the earn out be in the main sale agreement or a separate document?

Either can work, but many transactions include it in the main sale and purchase agreement or a detailed schedule to that agreement. The key point is that it must align with the rest of the deal terms.

What is better, revenue targets or profit targets?

Neither is automatically better. Revenue is often simpler to measure, while profit may better reflect value. The right choice depends on the business model, expected post-sale changes, and how much control the buyer will have over costs.

Can the buyer change how the business is run during the earn out period?

Usually yes, unless the contract restricts certain actions. That is why sellers should negotiate specific protections before they sign, especially if business changes could affect the earn out calculation.

What happens if the parties disagree on the calculation?

The answer should be in the dispute resolution clause. Many agreements send accounting disputes to an independent expert and leave broader legal disputes to another process, such as arbitration or court.

Key Takeaways

• An earn out agreement lets part of the purchase price depend on future business performance after settlement.
• The most important legal issue is precision, especially around the metric, formula, period, accounting treatment, and payment dates.
• Sellers should pay close attention to buyer control of the business after settlement, because operational decisions can affect whether the earn out is achieved.
• Good drafting should cover access to records, verification rights, dispute resolution, business restructuring, and the seller's post-sale role if they stay involved.
• Many disputes come from vague definitions, overcomplicated formulas, and poor alignment between the earn out clause and the rest of the sale documents.
• Before you sign, get the full transaction documents reviewed together so the earn out works commercially as well as legally.

If you want help with sale agreement drafting, contract review, earn out formula terms, dispute resolution clauses, or seller consultancy arrangements, you can reach us on 0800 002 184 or team@sprintlaw.co.nz for a free, no-obligations chat.