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Selling or buying a business?
Think about earn-outs

Mary sells her business with a promise by the purchaser to pay her 50% of the following year’s profit, that is, an earn-out.

Earn-outs enable a vendor to maximise the sale price of a business, with the ‘price’ delivered once a certain contingency, say, a profit target, is met.

A purchaser may intend to employ the vendor in the business after acquisition, so an earn-out may also be a de facto bonus mechanism.

Times change

Before October 2007, where a vendor received part of their sales proceeds as an earn-out, these proceeds equalled the market value of the earn-out when the earn-out right was created. The purchaser simply included the amount paid under the earn-out in their cost base of the assets acquired.

However, the ATO changed their views substantially on earn-out arrangements when they released their draft Taxation Ruling TR 2007/D10, particularly where an earn-out arrangement spanned multiple payments.

Now the purchaser is seen to have, at the time of contract, agreed to acquire assets and has, in return, given property, being the earn-out right. The purchaser must value the property to determine the cost of the assets they have acquired.

Tom acquires the goodwill of a business for 50% of next year’s profits. At the time of contract he considers that the market value of the earn-out right is $225,000. This will be the cost base of the goodwill.

Contact Frost Crane & Co with any queries on the sale or purchase of a business.

PO Box 2605
Carlingford NSW 2118

Unit 1
7 Lloyds Avenue
Carlingford NSW 2118

Phone +61 2 8820 2020
Fax +61 2 9872 7400