Earnout
A deferred component of M&A purchase price, payable to the seller after closing only if the target business achieves specified financial or operational milestones during a post-closing earnout period. Bridges valuation gaps between buyer and seller.
An earnout is a deferred component of M&A purchase price, payable to the seller after closing only if the target business achieves specified financial or operational milestones during a post-closing earnout period. Earnouts bridge valuation gaps between buyer and seller, the buyer pays only if the business performs as the seller projected; the seller participates in upside that the buyer is unwilling to pay for upfront.
Common metrics
Revenue-based: earnout tied to gross revenue or specific product-line revenue over the earnout period. EBITDA-based: earnout tied to EBITDA targets, typically over 1–3 fiscal years post-closing. Milestone-based: earnout tied to discrete events (regulatory approval, customer count, specific contracts). Combination: most earnouts use multiple metrics to balance buyer and seller incentives.
Earnout disputes
Earnouts are the leading source of post-closing M&A disputes. Recurring problems include: (1) buyer business decisions that reduce earnout metrics (deferred sales, product discontinuation, allocation of corporate overhead); (2) accounting interpretation disputes (especially around EBITDA adjustments); (3) integration choices that disrupt earnout-period operations; (4) implied covenant of good faith and fair dealing claims when buyer conduct appears designed to reduce the earnout.
Texas implied covenant of good faith
Texas does not generally recognize a freestanding implied covenant of good faith and fair dealing in commercial contracts. English v. Fischer, 660 S.W.2d 521 (Tex. 1983). However, post-closing earnout disputes frequently invoke express covenants (commercially reasonable efforts, ordinary course of business operations) or fraud / fraudulent inducement claims when buyer conduct departs sharply from expected behavior.
2024–2025 market trends
ABA's 2025 Private Target Deal Points Study reports earnout prevalence dropped to 18% of private deals (down from 26% in 2023), suggesting valuation gaps narrowed during the 2024–early 2025 period. Earnout structures became somewhat more buyer-favorable.
Earnouts work best where the metric is genuinely measurable, the earnout period is short (12–18 months), and the buyer commits to operating principles that protect earnout achievability. Long, complex earnouts are predictable sources of litigation.
Companion article: Selling Your Business in Texas