Earn-Outs in Education Business Deals: How They Work and When to Accept One

What is an earn-out in a business sale?

An earn-out is the part of the purchase price that is paid after completion only if the business hits agreed targets, so the seller earns it from future performance rather than receiving it on the day.

It is often confused with other ways of paying later. The difference is whether payment depends on performance.

Many deals combine them. A seller might take most of the price at completion, a small deferred amount, and an earn-out on top.

How does an earn-out work in practice?

It works through a set of defined terms in the Sale and Purchase Agreement, and every one of them needs to be written down precisely, because the seller no longer controls the business being measured.

The best earn-out clauses include a worked example using the business's own numbers, so both sides can see how a payment would be calculated before they sign.

Which metric should an education business earn-out use?

Choose the metric the seller can understand and verify and the buyer cannot easily distort: in education businesses that is often enrolment or revenue rather than profit.

For childcare centres, ECDA's rules shape the choice. On a transfer of licence, the new licensee takes over the existing fee structure, and fee increases can only happen after the transfer (ECDA Code of Practice s3.3.7, s3.3.8). Any increase in registration fee, deposit or programme fees also needs written notice to parents and ECDA no later than 1 September of the year before it takes effect (s9.2.1). That makes first-year revenue largely a function of enrolment at existing fees, which is useful when setting a target.

If you use EBITDA, define it from a normalised starting point and list the adjustments in the SPA. Our guide to normalised EBITDA and add-backs covers the usual items.

When does an earn-out make sense?

An earn-out makes sense when buyer and seller disagree on value because the future is genuinely uncertain, and the seller can still influence the result.

• Founder-dependent businesses: tuition and enrichment centres where students follow a particular teacher, or centres where parents chose the owner as much as the brand. An earn-out rewards the founder for a smooth handover.
• Enrolment uncertainty: a centre with a recent rise or dip in enrolment, or a newer centre still filling, where the buyer will not pay full value for numbers that may not hold.
• A price gap: where the seller's expectation rests on growth the buyer cannot yet see in the accounts.
• A seller staying on: where the founder will remain as principal, teacher or consultant for a transition period.

It makes less sense when the seller leaves at completion and cannot affect the outcome, or when the buyer plans to merge, rebrand or restructure the centre straight away, which makes the original business hard to measure.

What are the risks of an earn-out for the seller?

The main risk is that the seller is paid on results produced by someone else's decisions.

• The buyer may change fees, staff, curriculum or branding in ways that reduce enrolment during the period.
• Head office charges, new salaries or changed accounting policies can reduce profit-based targets.
• The buyer may resell, close or merge the centre before the period ends.
• The buyer may be unable to pay if its own finances weaken.
• Disagreement over the figures can turn into a dispute that costs more than the payment.

Treat the earn-out as uncertain money when you decide whether the overall price is acceptable.

How can sellers protect themselves in an earn-out?

Through drafting: clear definitions, limits on what the buyer can do, access to information and security for payment.

• Keep it short and simple. A short period and a simple metric leave less room for argument.
• Define everything. Write the metric, the accounting policies and a worked example into the SPA.
• Conduct covenants. Require the buyer to run the centre in the ordinary course, keep it as a separate business with its own accounts, and not divert children or staff to other centres.
• Information rights. Monthly or quarterly enrolment and financial reports, and the right to inspect the underlying records.
• Security. An escrow, bank guarantee, parent company guarantee or charge, so payment does not depend on the buyer's goodwill.
• Acceleration. Full or pro-rated payment if the buyer sells, closes or materially changes the centre, or breaches the covenants.
• Dispute resolution. Referral of disagreements on the figures to an independent accountant whose decision is binding.
• Your role. If you stay on, a written role, authority and pay, separate from the earn-out.

Ask your tax adviser how earn-out payments will be treated for you, and your lawyer to review the clauses before signing.

How do earn-outs work with ECDA's rules?

They sit alongside the licensing process rather than replacing any part of it, and the buyer carries the licensee's obligations from the transfer or change of control.

In a transfer of licence, the new licensee becomes responsible for the centre when ECDA approves the transfer (s3.3.7). In a share sale, new directors and anyone with general management of the centre are Key Appointment Holders, notified to ECDA at least 1 month before the change (s3.5). If the seller stays on as a director, they remain a Key Appointment Holder; if they stay on as principal, their deployment needs ECDA's approval like any principal (s4.2). See methods of a takeover for how each route works.

How Edugrow helps

Edugrow has advised on more than 70 education business transactions since 2014 and can draft a neutral Sale and Purchase Agreement, including earn-out or deferred payment terms that both sides understand, coordinating with lawyers where they are involved. If you are selling and a buyer proposes an earn-out, Edugrow can help you judge whether the structure is reasonable and negotiate the protections above. Read more about selling with Edugrow, or see how buyers fund deals in our guide to financing a takeover.