An earn-out arrangement is where the purchase consideration is structured such that an initial payment is made at the date of acquisition and the balance is paid depending upon the financial performance of the target company over a specified period of time.
The main advantages of earn-out arrangements are that:
Initial payment is reduced.
The risk to the predator company is reduced as it is less likely to pay more than the target is worth.
The price is limited to future performance.
It encourages the management of the target company to work hard as the overall consideration depends on future performance.