Earnouts: An Endless Source of Conflict…. that We Still Need
- Tim Christie
- Dec 15, 2025
- 9 min read
Updated: Dec 19, 2025
M&A Practitioners have a love/hate relationship with earnouts. Everyone has a list of stories about how they go sideways, yet they continue to play a critical role in getting deals done. In this article, we examine a number of critical issues: To understand why earnouts still matter, the practical steps buyers and sellers can take to negotiate them effectively, and the most common mistakes that lead to disputes. Perhaps understanding these basics will make your next earnout clearer, fairer, and far less painful.
Why We Still Need Earnouts
Buyers and sellers rarely see eye-to-eye on business value. Most deals come with a “hockey stick” of projections, and buyers naturally discount growth for execution risk, market uncertainty, or integration challenges. Sellers, meanwhile, argue their numbers are achievable—and, since many only sell once, they don’t want to leave money on the table.
Enter the Earnout: a portion of the purchase price tied to future performance. Earnouts are particularly useful when uncertainty or valuation gaps are high. They allow deals to move forward, aligning incentives so sellers stay motivated post-close while buyers protect against overpaying. They also provide clarity on operational priorities: a seller may focus on revenue growth, especially recurring revenue, while the buyer may care more about EBITDA or net income. Agreeing on the earnout sets expectations early and creates a foundation for smoother post-close integration.
Earnouts also encourage structured communication and reporting post-close, helping both parties monitor performance and address issues before they escalate. They convert potential conflict into measurable objectives, creating a shared focus on achieving agreed-upon results.
Of course, earnouts come with risks: misaligned metrics, weak covenants, or unclear reporting can create tension. But when structured thoughtfully, they remain a powerful tool to bridge valuation gaps, incentivize performance, and keep deals on track, particularly in high-growth or uncertain markets.
Finally, we believe strongly that earnouts, like most agreements, are strongest when both sides win. If both sides can set aside the "win-at-all-costs" mentality that is coursing through a deal, the earnout not only works well, but feel good....and that is the key to a lasting earnout.
At the end of the day, if an earnout helps two parties reach agreement on valuation, it is almost always better than walking away from the deal.
Negotiating an Earnout Agreement - Tips for Sellers
From an optimistic perspective, earnouts can be attractive for sellers in not only bridging value gaps (upwards for the seller) but also allowing that seller to bet on themselves. For a smaller company being acquired by a larger one, this can be material.
However, sellers negotiating an earnout need to be very mindful of some major challenges in the process and must proceed with “eyes wide open”. Below are a number of common themes to keep in mind when constructing your earnout:
Choose metrics you can influence. Revenue, ARR, customer retention, or unit volumes are commonly preferred, while EBITDA and profitability metrics are more sensitive to accounting decisions and less predictable. Many buyers believe that profitability measures are better for aligning an earnout, but our experience shows that these have less probability of success (see next bullet).
Negotiate operational covenants to protect the path to achieving earnouts. Sellers should secure commitments around budgets, staffing, and ongoing initiatives essential to hitting targets. While this may seem obvious, we’ve seen examples of earnouts where “corporate” reduced overall marketing spend to below pre-transaction levels at the seller, leaving a frustrated seller team without the tools to achieve their earnout. Without clarity and protections, buyer actions can unintentionally (or intentionally!) depress performance metrics.
Perform scenario modeling. We know there is a forecast – every deal has one. But once a seller begins to discuss an earnout, they should be aware of both the downsides and the upsides. A fair earnout provides the buyer some protection if the base case is not achieved, but the seller should likewise benefit if the outcomes are exceeded. To the point earlier – this is the definition of win-win, so be sure you, as a seller, are rewarded for exceeding your earnout targets.
Ensure transparent reporting and dispute resolution mechanisms are embedded in the agreement. Nobody ever looks back when earnouts are doing well, but they certainly do if targets are not achieved. The time to have this discussion is at the creation of the earnout when lack of performance is only theoretical, and this is the time to insert both validation metrics and procedures in case of a dispute. Don’t skip this part – it is often the most important part of the earnout.
In order to bring these concepts to life, engage experienced legal counsel who can guide you through the pitfalls and opportunities of an earnout. It is money well spent, particularly if your earnout is a significant component of the consideration in the transaction.
Yes, cash is king. But a well constructed earnout should be a way for a seller to “bet on themselves” and achieve a higher valuation. Sure, there are pitfalls, but by combining careful metric selection, operational protections, scenario planning, and transparent reporting, sellers can maximize the probability of achieving their earnout and preserve long-term value from the transaction.
Negotiating an Earnout Agreement - Tips for Buyers
In our experience, most buyers have an imperfect approach to earnouts. While the textbook goal is simple: protect downside risk while preserving operational flexibility and alignment with long-term strategy, we’ve seen buyers motivated by other tactics that attempt to lower the overall price of deal by loading up the earnout. This is a dangerous game that very often ends up settled by lawyers.
We recommend the win-win strategy where buyers achieve protection against downside risk, and the seller has the (real) opportunity to exceed the expectations modeled in the transaction. Finding a path for sellers and buyers to both succeed through exceeding expectations is the ultimate success of an earnout. As you think through your earnout strategy, consider the following issues:
Select objective, auditable metrics. There will be pressure from various departments in the acquiring company to “align incentives” related to profitability, but over time these metrics are the most litigated. Pick metrics tied to revenue, ARR, or customer retention that are generally simpler to monitor and harder to dispute. Clear definitions are critical.
The earnout should be created with a clear understanding of post-close operational flexibility. If there is an expectation that a target will operate independently, this is easier. But in the case of a significant integration process, defining the rights and responsibilities the seller needs to achieve their earnout is critical. Keep in mind that the seller likely doesn’t know what your internal operational or integrational strategies are when they sign the earnout, so the obligation is on the buyer to understand and clear potential roadblocks to success. Being forthcoming puts the seller in a better position to succeed and reduces conflicts later in the process.
Establish clear reporting obligations and audit rights. A defined cadence for performance reporting and the ability to verify results reduces the likelihood of disputes and provides transparency to both parties. Our experience shows that the more transparent the reporting, the better aligned the stakeholders remain.
Structure payout tiers and timelines thoughtfully. Partial payouts for partial achievement reduce “all-or-nothing” outcomes, align incentives and allow for (mutually agreeable) tweaks to the earnout documents. Further, putting in place dispute resolution mechanisms in advance, such as expert review or arbitration, can help prevent catastrophic ends to earnout agreements.
Perform scenario modeling. For the buyer trying to understand the optimal earnout, it should be like most compensation goals: a “stretch goal” for full payout. Something that is either too easy or too difficult to achieve is not effective. For example, if the earnout were to be impacted by cross-sell success, the buyer usually has a much better perspective on how existing customers might engage in the opportunity. Use that knowledge to contribute to a fairer earnout.
Engage appropriate legal experts. In most cases, the earnout is a significant emotional document for the seller. It may represent something core to the individuals involved (i.e. their life’s work), but at a minimum it will be extremely relevant financially. Take the process seriously and ensure your legal team drafting the earnout is experienced in the pitfalls and opportunities of the process.
When buyers focus on objective metrics, operational clarity, reporting, and thoughtful structure, they can limit overpayment risk while giving sellers a fair chance to earn contingent consideration. The goal should be an opportunity to win-win through a balanced earnout that aligns incentives and fosters smoother post-close collaboration.
Common Mistakes and Misunderstandings that Lead to Disputes
Generally, earnouts don’t fail because the concept is flawed. They fail because small ambiguities, operational changes, or accounting decisions compound into mistrust. After closing, both sides typically believe they acted reasonably—yet they end up interpreting the earnout mechanics differently.
Most earnout disputes stem from four recurring issues:
Metric Misalignment - Reflexively, buyers (particularly strategic acquirers) seek to align the earnout with “profitability”. Companies manage to a bottom line and worry that in order to reach the earnout, the seller will increase operating costs once the deal closes. Simultaneously, we’ve seen sellers confident of their profitability earnout at signing realize that their business now has internal charges like “Operational Overhead Allocation” that is significantly more than their previous operating charges.
We recommend making the earnout as simple as possible. While there is danger in a seller abusing the operational cost base, a focus on a simple and less contentious metric allows a more collaborative discussion. Working with measures such as revenue or ARR-based metrics is cleaner and negotiation /clarification on issues such as pricing, discounting, operational cost variances or cancellations can be handled separately in the document. Precise definitions and agreed calculation methods are essential.
Operational Control - In almost every earnout, the buyer and the seller have different opinions of operational control. Sellers often assume business operations will remain consistent post-close (because they are told this!?!) and buyers plan to integrate teams, adjust pricing, or reallocate budgets. At a minimum, the plans for cost synergies hatched early in the negotiations seem to be set in stone by the integration teams, usually implying consolidation of important operational head office functions like marketing, public relations, purchasing and HR.
Truthfully, there is no way to completely mitigate this issue. By definition, M&A involves change, so a seller that believes there is no change is in denial. But there are ways to mitigate the pain of this issue:
For the buyer, be transparent. You know the assumptions you used in creating a business case for this acquisition, so allowing a seller to believe “status quo” after the close is malpractice. Help to craft the earnout so that you think the earnout is possible in your environment, and as disputes arise at least you can start from a position of honesty.
For the seller, be realistic. If you know head office functions will be consolidated, seek to understand how centralized support will impact your business. Understand how business units are not only charged for service, but how you interact when you want more or less service. Most importantly, understand the parameters of your authority in the earnout. Be as clear as possible.
If you try to understand the earnout as an agreement to win-win, you are more likely to understand the scope of operational control and understand how it can be influenced over time.
Reporting Transparency - This is another issue we’ve seen backfire many times. An earnout is struck to which both sides agree and post close the sellers get started on earning their earnout. But the reporting transparency is absent – maybe because the acquirer cannot / does not create those reports.
In one project we worked on, an Executive on an earnout was promised that their authority would cover a geographic region. But the acquirer did reporting on lines of business. We spent 90 days trying to get reporting to reflect the targets in the earnout only to have the reporting fail and ultimately have the executive leave (with the vast majority of the earnout as a parting gift). An unambiguously failed earnout.
Dispute Resolution - The reason why most advisors dread earnouts is that they are extremely hard to do well. From a buyer’s perspective, poorly structured earnouts tend to be settled by lawsuit, and tend to result in the seller getting a larger share of the anticipated payout than expected. From a seller’s perspective, the poorly worded earnout becomes a major source of frustration and regret as the targets are unachievable.
Poorly structured earnouts often end up in formal disputes. But even well-crafted earnouts should anticipate what can happen in worst-case scenarios as even with clear metrics, disagreements can and do occur. Embedding mechanisms such as independent expert review, accounting arbitration, or pre-agreed calculation rules can streamline resolution and preserve relationships.
The Value of Good Legal Counsel
As we’ve seen, there is a minefield of problems in earnouts and it is important that what the buyer and seller agree to is codified in the agreement. And despite the best intentions, sometimes earnouts simply fail.
It is therefore an important reminder that good attorneys on both sides help to ensure that all of the key concepts are covered, including, critically, what happens when one or both parties need to terminate the earnout agreement. Nobody wants to plan for it, but it is well worth the time and expense to clearly articulate the rights and obligations of both parties in the foundational document.
Don’t let the challenges of earnouts scare you off: a well-structured earnout should be able to create value in excess of a simple one-time purchase price. That said, adequate attention to the motivations and details of the earnout document needs to be taken, hopefully with support of professionals who can provide trusted advice.
CorpDev Consulting has decades of experience supporting both buyers and sellers through the transaction process. If you need support with M&A or other inorganic growth strategies, contact us today to see how we can best support you!
Written by Tim Christie
December 2025
Good article.