When is an "earn-out" a potentially good solution for agreeing on terms of a deal?

An earn-out is a financial arrangement in which a portion of the purchase price is contingent upon the future performance of the acquired business. It is particularly useful in situations where the buyer and seller have differing opinions on future financial projections. In this context, the earn-out serves as a compromise that allows both parties to share the risk associated with the uncertainty of future performance.

When the buyer believes that the acquired company may perform better than what the seller suggests, an earn-out structure can mitigate the buyer’s risk by tying the additional payments to the company's actual performance post-acquisition. This creates an incentive for the seller to continue driving the business forward, as they will benefit from achieving certain financial milestones after the deal closes. It also allows the buyer to limit their initial financial outlay, while giving the seller the opportunity to receive a higher total payout if the company performs well.

The other scenarios mentioned do not typically justify the use of an earn-out. For example, if both parties agree on future financial projections, there would likely be less need for an earn-out since both sides already have aligned expectations. Similarly, the size of the deal or the relative market knowledge of both parties do not inherently lead to the complexities and uncertainties that earn-outs are designed to address. Therefore