In today’s market, business acquisitions are increasingly sophisticated; rising interest rates, more cautious lending practices and heightened due diligence have increased the difficulty to reach agreement on price and terms.
Throw in the economic measures introduced in the 2026/27 Federal Budget, and the structure of a transaction has become just as important as price with Buyers increasingly focused on preserving working capital and managing risk.
Earn-outs and working capital adjustments are valuable tools for bridging valuation gaps in this market, managing cash flow and reducing transaction risk. When structured properly, these mechanisms can make the difference between a transaction proceeding or falling apart in negotiations. However, whilst commercially attractive, these arrangements require careful consideration so that parties don’t find themselves at the centre of an expensive dispute.
Why are deals increasingly structured this way?
The current transaction landscape often gives rise to differing valuation expectations – sellers confident in future growth, and buyers cautious about economic conditions, customer retention, labour costs and the sustainability of earnings. Instead of debating a simple purchase price, parties are implementing frameworks allowing part of the value to be determined after settlement based on objective financial outcomes. This ultimately allocates risk between them with the hope that the transaction provides greater flexibility and an increased likelihood of completion.
Earn-outs – Paying for Future Performance
An earn-out allows for part of the purchase price to be paid after settlement if the business achieves agreed performance targets, such as EBITDA or net profit, customer retention, production milestones or any other measurable key performance indicator.
It is a particularly common arrangement where the seller will remain involved in the business following settlement, or where future growth is anticipated but not necessarily guaranteed.
The advantages
For a buyer, using an earn-out structure reduces the risk of overpaying for projected growth. For sellers, it provides the opportunity for a higher sale price when the business performs well. The core benefit is that it can bridge a valuation gap, whether large or small, between the parties.
The legal challenges
Even for all of its negotiation benefits, earn-outs often generate disputes due to the nature of relying on events after settlement. Common issues include determining how performance is measured or what accounting standards apply.
A well drafted earn-out clause should clearly address factors including the calculation methodology, reporting obligations, dispute resolution procedures and timeframes for payment.
Working Capital Adjustments – Protecting the Value of the Business
A working capital adjustment ensures the buyer receives the business with an agreed level of operating capital on completion. Under this mechanism, the parties agree on a target level of working capital based on the historical operations of the business over an agreed period. This prevents either party manipulating the balance sheet prior to completion and provides an objective benchmark for calculating adjustment. If a seller withdraws excessive cash, delays paying creditors or collects debts before settlement, the buyer may inherit a business that requires immediate funding.
Shortly after settlement, completion accounts are prepared comparing the actual working capital delivered against the agreed target. If the actual working capital is:
- Higher than the target, the purchase price may increase, or
- Lower than the target, the purchase price is reduced
This ensures that the buyer pays for the business that was negotiated – not one that has been stripped of assets required to continue operating.
Why are working capital adjustments important?
Working capital adjustments provide certainty for both parties by ensuring the business is transferred on a consistent operational footing. For buyers, they avoid the unexpected cost of injecting additional funds immediately after settlement. For sellers, they provide a transparent methodology for determining the final purchase price while reducing the scope for post-completion disputes.
The legal considerations
Although conceptually straightforward, working capital adjustments can give rise to disputes where the sale agreement lacks sufficient detail. Common issues include
- Which assets and liabilities are included in working capital
- How stock is valued
- Treatment of doubtful debts or provisions
- Accounting policies to be applied
- Preparation and review of completion accounts
- The process for resolving disagreements between the parties
A well drafted agreement clearly defines each component of working capital, prescribes the accounting methodology to be used and establishes a practical dispute resolution process, often involving an independent accounting expert.
Choosing the Right Structure
Every transaction presents different commercial risks, and no single pricing mechanism is appropriate in every deal.
- An earn-out may be suitable where future profitability or growth remains uncertain.
- A working capital adjustment protects both parties by ensuring the business is transferred with an appropriate level of operating capital.
Increasingly, sophisticated business acquisitions incorporate a combination of these mechanisms. A buyer may pay most of the purchase price at settlement, have a working capital adjustment on completion, and provide an earn-out linked to future performance.
By allocating different risks to different pricing mechanisms, hybrid structures can bridge valuation gaps whilst providing parties with greater confidence that the transaction reflects the true value of the business.
Final Thoughts
Successful acquisitions are rarely achieved through price negotiation alone. Increasingly, they are achieved through thoughtful transaction structuring that balances commercial objectives with legal certainty.
Whether through earn-outs or working capital adjustments, carefully structured transactions preserve commercial relationships and improve the prospects of successful completion. The right legal framework doesn’t simply document the deal – it helps ensure the deal succeeds.
Natalie Melia
| Special Counsel | |
| Business Depot Legal Pty Ltd | |
| [email protected] | |
| 02 9127 2727 |