Designing Earn-Outs that Don't Backfire
Earn-outs fail when their design drives the wrong behaviour. If the structure misaligns incentives, limits cooperation, or leaves room for interpretation, it can lead to disputes, delay integration, and complicate post-closing relationships.
Core Insights
Design for incentives, not hope. Earn-outs work only if they motivate the people driving results. If founders or key managers are staying, tie the payout to metrics they can control, not figures buried in consolidated financials. If they’re not staying, avoid the earn-out structure altogether.
Predict conflict. Write it out. Disputes don’t typically come from bad faith; they come from ambiguity. Decide upfront who calculates, who reviews, and how disagreements get resolved. The best structures use independent accountants, short objection windows, and final, binding determinations.
Accelerate with purpose. Acceleration clauses (for a sale, buyer breach, or management termination) are about fairness. If a buyer changes the game midstream, sellers should still share in the upside. Planning for these scenarios avoid imbalanced hostage negotiations later.
Risk defines structure. Traditional earn-outs make sense in higher-risk or more volatile situations, because they defer part of the purchase price until performance proves out. Reverse earn-outs can be used in lower-risk or more predictable contexts, where the buyer is comfortable paying upfront and the seller effectively “gives back” value only if results fall short.
Takeaway
The best earn-outs turn uncertainty into alignment: structuring risk, incentives, and trust so both sides stay invested in the same outcome with minimal opportunities for dispute.
Ink LLP is a business law firm with focused expertise in venture capital, mergers & acquisitions, and complex commercial transactions.
This information is provided for informational purposes only, is highly generalized, and is not legal advice.