By Vikrant Rana and Shantam Sharma
India’s dealmaking story in 2025 has been defined by resilience. Even as global macroeconomic uncertainty dampened sentiment, the country recorded transactions worth USD 50 billion in the first half of the year, with renewable energy, financial services and consumer businesses drawing the largest flows[1]. Beneath this momentum lies an old problem. Buyers and sellers often cannot agree on what a company is worth today. For startups, where value rests on potential more than past earnings, the gap can be wide. The mechanism most frequently used to bridge it is the earn-out.
An earn-out allows part of the consideration to be paid on closing and the remainder only if the target achieves specific milestones over an agreed period. In essence, the buyer pays for performance once it is delivered, while the seller gets an opportunity to prove the growth story they are confident about. It is a device that aligns incentives, reduces immediate risk for the acquirer, and keeps the founder motivated post-transaction.
What Earn-Outs Look Like in Practice
In Indian startup deals, the milestones are usually financial such as revenue, EBITDA or net profit. Increasingly, acquirers and founders are experimenting with user growth targets, regulatory approvals or even intellectual property creation. The earn-out period internationally runs three to four years. In India, Reserve Bank of India rules cap deferred consideration at 25 percent of the purchase price and restrict the period to 18 months unless special approval is obtained. This often forces creative structuring, including the use of preference shares, retention bonuses or consultancy arrangements to replicate the effect of a longer earn-out.
For earn-outs to function, governance during the post-deal period becomes critical. A founder who is responsible for hitting the targets must also retain enough operational freedom to do so. Otherwise, the risk is asymmetrical. The seller carries the burden of performance without the authority to shape outcomes. This is why negotiation around management rights, veto powers, reporting obligations and standstill provisions becomes as important as the headline price.
Key Terms at the Negotiation Table
| Term | Explanation |
| Upfront Payment | Consideration paid on closing, sometimes reduced to account for risk. |
| Deferred Consideration | Balance consideration, contingent on milestones. |
| Milestones | Financial (EBITDA, revenue) or non-financial (user growth, IP, regulatory approvals). |
| Earn-Out Period | Typically 2–4 years globally, in India capped at 18 months unless RBI approval is secured. |
| Management Rights | Autonomy or veto powers granted to sellers to influence performance. |
| Dispute Resolution | Arbitration or independent expert determination to address disagreements. |
These elements are rarely boilerplate. Each deal requires careful calibration depending on the sector, the role of the founder after closing, and the regulatory environment in which the company operates.
The Tax Dimension
If valuation drives the commercial debate, taxation often complicates it. The Income-tax Act, 1961 does not contain a provision dedicated to earn-outs. Courts have therefore stepped in to determine their character. The first question is whether the payment is part of the purchase price, taxable as capital gains, or whether it should be regarded as income, either salary if linked to employment, or business income if linked to services. The second question is timing. Should tax be levied when the transfer occurs, even though the payment may never be received, or only when the contingent sum is actually paid?
Tax Treatment Scenarios
| Scenario | Treatment | Implication |
| Linked only to share or business transfer | Capital Gains | Part of consideration, taxed under Section 45. |
| Linked to continued employment | Salary (profits in lieu of salary) | Taxable under Section 17, up to 30% plus surcharge. |
| Linked to consultancy or advisory role | Business Income | Taxable under Section 28 as professional earnings. |
Case law illustrates the contrasting positions. In Anurag Jain[2], In re, upheld by the Madras High Court, payments tied to continued employment as CEO and linked to EBITDA targets were treated as salary rather than genuine sale consideration3. In Moody’s Analytics Inc.[3], however, the AAR in New Delhi concluded that since the seller had no continuing role and the payment was linked only to company performance, the amount qualified as deferred consideration and formed part of capital gains.
Even within capital gains, timing has been contentious. The Delhi High Court in Ajay Gulia held that the full value of consideration, including contingent payments, must be taxed in the year of transfer[4]. The Bombay High Court in Hetel Raju Shete, by contrast, ruled that such sums should be taxed only on actual receipt, since there was no certainty that the milestones would be achieved[5]. The divergence leaves sellers exposed to differing interpretations depending on jurisdiction, making tax planning inseparable from commercial negotiation.
The Negotiation Tightrope
For founders selling their companies, the earn-out period can feel like a second entrepreneurial journey, only this time under the shadow of new ownership. The buyer’s priority is risk management, while the seller’s priority is upside capture. Aligning these priorities requires more than clever structuring. It demands foresight into how financials will be measured, how decisions will be made, and how disputes will be resolved.
In India, where cross-border flows are common and regulatory guardrails are tight, the design of an earn-out cannot be an afterthought. In the recent years, it has been observed that billion-dollar deals are clustering in sectors like renewable energy and consumer products1. In both these spaces, growth trajectories are steep but uncertain. Earn-outs will therefore continue to play a central role in unlocking deals that might otherwise stall on valuation.
Closing Thoughts
Earn-outs are not inherently good or bad. They are a tool, useful when applied thoughtfully and risky when drafted poorly. For Indian startups, they offer a path to reconcile optimism about the future with the pragmatism of acquirers who prefer proof over promise. The challenge lies in navigating the fine print, balancing clarity in contracts, anticipating tax consequences, and staying mindful of regulatory ceilings. If these aspects are addressed upfront, earn-outs can turn potential deadlocks into successful deals, allowing India’s startup ecosystem to continue its trajectory of consolidation and growth.
[1] EY Transactions Newsletter, August 2025.
[2] Anurag Jain, In re [2005] 145 Taxman 413, AAR; upheld in Anurag Jain v. AAR [2009] 183 Taxman 383 (Madras HC).
[3] Moody’s Analytics Inc., USA [2012] 24 taxmann.com 41 (AAR – New Delhi).
[4] Ajay Gulia v. ACIT [2019] 417 ITR 118 (Delhi HC).
[5] Hetel Raju Shete v. ACIT [2016] 382 ITR 482 (Bombay HC).