Earn-Out: the price that is only decided after the sale

Every negotiation to buy or sell a company runs, sooner or later, into the same question: what is this company really worth? On one side, the seller projects a glorious future. On the other, the buyer sees the risk of overpaying for a promise that may never come true. It is precisely in this gap between expectations that the earn-out is born, the mechanism that ties part of the price to the future performance of the acquired business.

First, a number that frightens. In September 2024, Delaware’s Court of Chancery, the world’s most respected court in M&A disputes, found Johnson & Johnson liable for breaching its obligations and for fraud in the earn-out from its purchase of Auris Health, a surgical-robot maker acquired for US$ 3.4 billion up front, with up to US$ 2.35 billion in additional payments tied to development milestones. J&J, which was already developing its own robot, decided to merge the two platforms, delayed the project, missed the milestones and was also caught having promised, at the outset, something it never intended to deliver. The result: one of the largest earn-out disputes ever seen, with J&J ordered to pay US$ 1 billion in damages (which this year was partially reduced).

If it happens to Johnson & Johnson, imagine the rest of us?

The earn-out is an extremely useful tool, but it can also be a double-edged sword. Well designed, it unlocks deals that would die at the table over a price gap. Poorly designed, it simply pushes the fight to after closing, when there is no goodwill left, nor trust. As Delaware Vice-Chancellor J. Travis Laster put it with surgical precision, an earn-out often “converts today’s disagreement over price into tomorrow’s litigation over outcome” (Harvard Law School Forum on Corporate Governance). Remember that phrase. It sums up everything that follows.

After all, what is an earn-out and why has it become fashionable

In practice, the earn-out is a clause in the purchase agreement (the SPA, short for Stock or Share Purchase Agreement) that splits the price into two parts: one paid at closing and another, variable, that only lands in the seller’s account if the company hits certain targets over an agreed period. Hit the target, the seller pockets the extra. Miss it, the buyer pays less. It is a contingent payment, technically an obligation subject to a condition precedent, in the language of our Civil Code.

Why is it gaining more and more traction? Because the environment calls for it. With high interest rates – in Brazil running around 14-15% a year – and a cost of capital that squeezes the buyer, no one wants to pay 100% of the price up front for optimistic projections. The earn-out solves four problems at once: (1) it reduces the buyer’s initial check, (2) it allocates performance risk between the parties, (3) it keeps the seller engaged in the business after the sale and, above all, (4) it builds a bridge over the valuation gap when comparable transactions or reliable projections are lacking. No wonder the life sciences sector, where a company’s value depends on clinical trials and regulatory approvals, uses earn-outs in more than 80% of transactions, according to data compiled by SRS Acquiom (cited in the A&O Shearman study published on the Harvard Law School Forum on Corporate Governance).

What the market looks like: numbers every seller should know

The earn-out is no longer exotic. According to the American Bar Association study on private-target deals, the use of the clause outside life sciences jumped from 15% in 2019 to 33% in 2023, receding to 22% in 2024 and rising to 24% in 2025. In other words, roughly one in four private transactions today carries an embedded earn-out. That’s a lot of people betting part of the price on the future.

And we’re not talking pocket change. The median earn-out outside life sciences represented 31% and 34% of the amount paid at closing in 2024 and 2025, respectively, according to the SRS Acquiom 2026 M&A Deal Terms Study. In the health and biotech sector, that share approaches 61% of the total: more than half the price is left hanging on future targets. As for duration, the median measurement period outside life sciences hovered around 21 months in 2025, while labs and pharmaceutical companies live with periods of three to five years, or more.

Here’s a rule of thumb: the larger the share of the price allocated to the earn-out and the longer the measurement period, the greater the chance of a dispute. It’s the mathematics of human behavior. More money at stake for more time means a higher probability that the parties’ interests will diverge along the way.

The battle of the metric: revenue or EBITDA?

If there is one point where buyer and seller sit on opposite sides of the table, it is the choice of metric. The seller almost always prefers the trigger to be revenue. It’s the top line of the income statement, hard to manipulate by changing the cost structure or accounting treatment. The buyer, on the other hand, prefers profit or EBITDA, because they reflect real profitability, not just sales volume.

On average, the middle ground tends to be EBITDA. It already incorporates operating costs, unlike pure revenue, but excludes non-operating items such as interest, taxes and depreciation, which, in theory (only in theory – I’ll publish a post about this soon) makes it less susceptible to subjective adjustments than net income. That’s why EBITDA targets appear so often in negotiated deals: they balance the seller’s search for predictability with the buyer’s demand for financial rigor. Recently, in fact, earn-outs have grown more sophisticated, combining financial metrics with non-financial milestones, such as customer retention or, in the energy sector, the price of a benchmark commodity.

What the courts teach: four cases not to forget

Theory is nice, but real cases teach more. No earn-out contract survives contact with reality intact, and Delaware’s courts have become a kind of laboratory of other people’s mistakes. It’s worth learning at others’ expense.

Back to Fortis Advisors v. Johnson & Johnson. J&J’s central error was not commercial, it was one of conduct. The contract required “commercially reasonable efforts” measured by the standard J&J would apply to a priority device of its own, and the court concluded that the company departed from its own practices when integrating Auris’s technology into its own. Worse: it lied about its intentions during the acquisition. The lesson I take from this is hard and simple. A poorly defined effort standard, combined with verbal promises that never make it into the contract, is a recipe for tragedy. That’s why non-reliance clauses are so common in the U.S., making explicit that each party relies only on the representations written in the agreement, and not on verbal sources or hallway conversations.

The second case is Shareholder Representative Services v. Alexion Pharmaceuticals. Alexion paid US$ 400 million up front for Syntimmune and promised up to US$ 800 million in earn-out tied to the development of an antibody. Along the way, Alexion itself was acquired and decided to abort the project for synergy with its new parent. The court did not forgive it: the contracted effort standard was “outward-facing,” that is, it measured Alexion against what a comparable company would do, and the court found that halting development out of self-interest fell below that standard. The moral: if you, the buyer, agree to be compared to your peers, you can’t later claim the decision was “good for your business.” The benchmark is not you.

The third case pleases me because it shows the other side. In Menn v. ConMed, the buyer had committed to using its “best commercial efforts,” paid 87.8% of the possible earn-out and then discontinued the product over safety problems. The seller went to court after the rest. The court sided with the buyer, because it had dedicated a qualified team to redesign the product and the possibility of stopping for safety reasons was expressly stated in the contract. Note the contrast: J&J lost for bad faith, ConMed won for having acted in good faith and for having provided for the exit on paper. The difference between one ruling and another sometimes lies in the details of the drafting.

The fourth case is almost an anecdote, but it cost US$ 40 million. In Schneider National Carriers v. Kuntz, the contract required the buyer to acquire “60 trucks” per year, on pain of paying the full earn-out. The problem? The parties fought over what “60 trucks” meant: buying 60 units or increasing the fleet by 60 net units. Four days of trial, nearly 300 documents reviewed, and the buyer ended up ordered to pay. All because of two ambiguous words. If that doesn’t convince someone to take care with the drafting, I don’t know what will.

And in Brazil? Startups, taxes and objective good faith

Here at home, the earn-out found fertile ground in the world of startups and technology companies, precisely where uncertainty about the future is greatest. A buyer acquiring a company with thirty or forty years on the road has a track record to lean on. Whoever buys a startup is buying, to a large extent, a bet. And a bet is structured with a contingent price. No wonder the mechanism shows up frequently in acquisitions of SaaS businesses, with targets tied to customer retention and subscriber-base growth, which aligns the seller’s interest with the long-term sustainability of the business.

The most emblematic example we have in the country is iFood. When Prosus consolidated full control of the company by buying out Movile’s stake, the deal was structured with a payment up front plus contingent consideration of up to 300 million euros, tied to performance. It’s an earn-out in its purest form, in the largest technology deal in our recent history. Proof that the mechanism operates across every price range.

Brazil’s M&A market, by the way, remains reasonably heated despite high interest rates. The KPMG Mergers and Acquisitions Survey counted 1,581 transactions in 2025, practically tied with 2024, moving around US$ 51 billion, with a marked advance by private equity and venture capital funds, which reached half of all deals. In an environment of expensive money, the earn-out stops being a luxury and becomes a tool for the survival of the business.

There are, however, two Brazilian peculiarities no one can ignore. The first is tax. How the earn-out is characterized – whether as a portion of the price subject to capital gains or as disguised compensation for services of a seller who stays on in management – radically changes the tax burden and has already sparked significant disputes with the Federal Revenue Service. Structuring it without sitting down with a good tax adviser is an invitation to loss. The second is objective good faith, set out in Article 422 of the Civil Code, which permeates every contract in Brazil and works much like the implied covenant of good faith and fair dealing of U.S. law: the buyer is not required to maximize the seller’s earn-out, but cannot deliberately act to sabotage it. The line between legitimately running the business and undermining the seller’s payment is thin, and it’s on that line that disputes live.

How to structure an earn-out that doesn’t become a lawsuit

After more than twenty years sitting at this table, I’ve condensed into a few principles what separates a successful earn-out from a time bomb. It’s no magic formula, but it covers most of the mistakes I’ve seen prove costly:

• Define the milestones with a focus on clarity. “Revenue,” “the company’s product,” “profit”: each term needs an objective definition and, where possible, numerical examples attached to the contract. It was the absence of a definition of the expression “Company Products” that cost the buyer millions in Fortis Advisors v. Dematic.
• Choose and spell out the effort standard. Will it be “outward-facing,” measuring the buyer against its peers, or “inward-facing,” against its own practices? The Delaware court has already made clear that arguing over whether the standard is “commercially reasonable efforts” or “reasonable best efforts” is a waste of time, because the courts treat those variations as equivalent. What matters is describing, in detail, what is expected of the buyer.
• Negotiate the post-closing covenants. The seller typically asks that the business be run as before, operated as a separate unit, with its own books and no new debt. The buyer resists anything that ties down its management. The balance is case by case, but contractual silence here is fertile ground for litigation.
• Consider the objective alternative. Instead of arguing over what a “reasonable” effort is, some parties agree that the buyer will invest a fixed amount in development, for example. Spend the amount, the obligation is met, whether or not the target is hit. It’s objective, reduces litigation and works well when costs are predictable.
• Document everything, starting with the LOI. Letters of intent, the Info Memo, e-mails among the principals, earlier versions of the contract: when a term turns out to be ambiguous, it’s that archive that decides the game. Also keep a record of the efforts actually made to hit the targets.
• Provide for acceleration and a buyout clause. It’s worth agreeing that, in the event of a change of control or the departure of a key executive, the earn-out is accelerated. And the buyer may want a buy-out option, paying the earn-out at a discount to free itself from the operational strings. Just write clearly whether the acceleration covers the entire earn-out or only what has already been earned under the targets at that point.

Notice the common thread: virtually every earn-out dispute is born of ambiguity or poorly documented conduct. Not of bad luck. The earn-out contract is, by nature, bespoke, and for that very reason it admits no generic template. Involve the legal, financial, accounting and tax teams from the first draft. Is it expensive? It is. More expensive than an arbitration or court proceeding? Never.

The earn-out isn’t always the best bridge

One warning I give every client: the earn-out is not the only way to close a valuation gap, and sometimes it isn’t even the best. When the difference between what the seller asks and what the buyer offers is small, it often pays more to settle it with an up-front price adjustment than to carry two or three years of targets, reports and potential for a fight. There are also incentive compensation for the executives who stay with the company and staged, step-by-step purchases, each with its own tax, accounting and benefit implications. The earn-out is powerful, but it is not dogma. It’s not worth choosing the tool merely because it’s in fashion.

In the end, an earn-out is a bet made by two parties on a future that no one fully controls. And every two-party bet only works when the rules are written with such clarity that not even the most creative lawyer can distort them. The buyer may well buy the company today. But the earn-out only delivers what was agreed if, before the money, the parties have bought trust and clarity.