An earnout sounds like a clean solution when a buyer and seller cannot agree on price. The seller thinks the business is worth more. The buyer is not convinced. So they agree to pay part of the price later, based on how the business performs. In theory, everyone wins.
In practice, earnouts are one of the most common sources of post-closing disputes I see. Here is why they cause trouble and how to structure one that has a fighting chance of working.
1. Why buyers and sellers reach for earnouts
Earnouts are often used when there is a genuine, good-faith disagreement about future performance, particularly for businesses with concentrated customers, a new product line, or growth that has not yet been proven out. Rather than walking away, the parties agree to let future results settle the argument.
They can also help buyers manage cash flow by spreading part of the purchase price over time, contingent on the business hitting agreed targets.
2. The core problem: who controls the business during the earnout period
Once the deal closes, the buyer generally controls the business. But the seller's earnout payment depends on how that business performs. That creates an obvious tension.
Sellers worry the buyer will run the business in a way that suppresses the metrics tied to the earnout, whether by cutting marketing spend, changing pricing, folding the business into a larger division, or shifting costs onto the acquired unit. Buyers, for their part, do not want their hands tied on legitimate business decisions just because a former owner has a financial stake in short-term numbers.
3. Defining the metric matters more than people expect
Earnouts tied to revenue tend to generate fewer disputes than earnouts tied to profit, because profit can be affected by allocation of overhead, accounting choices, and decisions made well after closing. Whatever the metric, it needs a precise, unambiguous definition in the purchase agreement.
I push clients to define exactly how the metric will be calculated, which accounting standards apply, and how disputes over the calculation will be resolved. Vague language here is where most future fights start.
4. Operating covenants can reduce, but not eliminate, the risk
Well-drafted earnout provisions often include operating covenants that limit what the buyer can do during the earnout period, such as restrictions on diverting customers, cutting resources needed to hit the targets, or making structural changes to the business without the seller's input.
These provisions help, but they cannot anticipate every decision a buyer might make. Some tension is generally unavoidable when one party controls the business and another party's payment depends on the outcome.
5. Consider whether an earnout is even the right tool
Before agreeing to an earnout, it is worth asking whether the valuation gap could be addressed another way, such as seller financing, a holdback, or simply adjusting the price. Earnouts make sense in some deals. In others, they introduce more risk and litigation exposure than the disagreement over price ever justified.
When an earnout is the right tool, the purchase agreement needs to do the heavy lifting: clear definitions, clear calculation methods, clear dispute resolution, and realistic operating covenants.
Earnouts can bridge a real gap between buyer and seller, but only when they are built carefully. If you are negotiating a deal that involves an earnout, reach out through blgattorney.com or call my Oklahoma City office before the terms are set in stone.