Selling a Business

Earn-outs From the Seller Side

Treat an earn-out as an option you wrote for free, then make it collectable: with the right metric, defined accounting, explicit operating covenants, and acceleration triggers that survive a change of plan.

  • Advanced
  • 9 min total
  • 12 chapters

What decision this helps you make: Whether to accept an earn-out at all, and if so on what metric, over what period, with which protective covenants.

What this topic is

Deferred, contingent purchase price payable if the business meets defined targets after closing. This lesson covers metric selection, the accounting definitions that determine whether a target is met, the post-closing operating covenants that protect the measurement, acceleration and set-off provisions, the tax treatment of contingent consideration, and what courts have actually done when a buyer runs the business in a way that defeats the earn-out.

Why it matters

Earn-outs are how a price gap is bridged, and they are the single most litigated provision in private M&A. The seller hands the buyer control of the measurement and then asks the law to police it. The implied covenant of good faith is thinner protection than sellers expect. Courts have repeatedly declined to require a buyer to maximise an earn-out absent an express covenant. Everything that protects a seller has to be written down.

Who should learn it

Owners offered an earn-out, and advisers drafting or negotiating one.

What you will understand

  • Why the choice of metric is the most important term, and why revenue usually beats EBITDA for a seller
  • The accounting and operating covenants that determine whether a target is achievable
  • What Delaware courts have and have not required of buyers under the implied covenant
  • How contingent consideration is taxed, including imputed interest and the compensation risk

Prerequisites

Common misconception

"If the buyer runs the business badly, the courts will make them pay." Generally not. Delaware has held that absent an express contractual obligation, a buyer has no implied duty to maximise an earn-out, and that the implied covenant does not supply terms the parties failed to negotiate. What is actionable is conduct undertaken with the intent to defeat the earn-out, which is much harder to prove. Protection comes from express covenants, not from good faith.