Earn-Outs in M&A: A Double-Edged Sword
This mechanism is often full of hidden traps
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An earn-out may seem like the perfect solution to bridge a valuation gap in an M&A deal.
The problem? that can leave sellers empty-handed when it comes time to collect.
Here are some key risks and how to avoid them—backed by real examples. 👇
1. The Risk of Overly Ambitious Projections
👉 Example: A cybersecurity SaaS presents a business plan projecting 50% annual growth to justify a generous earn-out. After the deal closes, market reality kicks in, and growth is only 15%. Outcome: The seller walks away with nothing.
✅ How to avoid it: Ensure earn-out targets are realistic and account for market fluctuations.
2. Loss of Operational Control Post-Closing
👉 Example: The founders of an e-commerce startup sell their company with an EBITDA-based earn-out. Post-acquisition, the buyer changes pricing strategy, reducing profit margins. The founders lose control… and their earn-out.
✅ How to avoid it: Define post-closing decision-making authority and ensure strategic changes don’t unfairly impact earn-out metrics.
3. Financial Manipulation
👉 Example: A software company is acquired with an EBITDA-based earn-out. After closing, the buyer starts allocating corporate overhead costs—like CEO and CFO salaries from the parent company—artificially lowering EBITDA. The business performs well, but the reported EBITDA shrinks… and the seller never sees their earn-out.
✅ How to avoid it: Clearly define which costs will be allocated to the acquired company in the purchase agreement.
4. Who Actually Receives the Earn-Out?
👉 Example: Before closing the sale of a marketplace, a conflict arises between founders and minority shareholders. The founders—who will remain in the company—argue that they should receive the earn-out since they are responsible for meeting the targets. Meanwhile, exiting shareholders want their share because the company was sold at a price that includes this mechanism.
The buyer, on the other hand, only wants to commit additional payments to those staying on. If this discussion isn’t resolved before closing and properly documented, it can escalate into legal disputes or internal conflicts post-acquisition.
✅ How to avoid it: Align expectations early and clearly define earn-out recipients in the deal structure.
5. Dispute Resolution Clauses
👉 Example: A gaming studio sells its company with a revenue-based earn-out. When the numbers don’t match expectations, a dispute arises between the buyer and sellers. Fortunately, thanks to a well-defined arbitration clause, the issue is resolved without years of litigation.
✅ How to avoid it: Always include clear dispute resolution mechanisms in the agreement.
Final Takeaway: Don’t Let an Earn-Out Turn Your Exit Into a Nightmare
A poorly structured earn-out can jeopardize your deal and leave you empty-handed. Protect yourself by:
1. Defining clear, achievable targets
2. Safeguarding operational control
3. Establishing ironclad financial protections
4. Implementing strong dispute resolution clauses
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