Earnouts in Business Sales: How to Structure Them
By Nadine Deeb, Esq. · Published June 13, 2026 · Updated July 2026
An earnout can make a business sale possible when the buyer and seller disagree about value. The seller believes the business is worth more because growth is coming; the buyer will not pay full price upfront because future performance is uncertain. An earnout tries to bridge that gap by making part of the purchase price depend on what happens after closing. That can be useful. It can also be risky.
Key takeaways
- • If the earnout formula can be interpreted two ways, there is a good chance it will be.
- • After closing, the buyer usually controls the business — and the levers that determine whether the earnout pays.
- • Reporting, access, and audit rights are what let a seller verify the numbers instead of taking them on faith.
- • Earnouts carry tax consequences — installment sale, allocation, and income-character issues — that should be reviewed before signing.
Quick answer: an earnout is a business-sale provision where the seller receives additional purchase price after closing if the acquired business achieves certain financial, operational, customer, product, or performance milestones. Earnouts are often used to bridge valuation gaps, but they can create disputes if the agreement does not clearly define the metrics, calculation method, buyer obligations, seller access rights, timing, reporting, tax treatment, and dispute process.
At Accord & Shield Legal, we have seen how earnouts can turn into post-closing disputes when the formula is vague, the buyer controls the business after closing, the seller no longer has access to records, or the parties never clearly defined revenue, EBITDA, milestones, timing, or accounting methods. Earnouts should not be treated as simple “pay later if things go well” provisions. They are complex deal terms that need careful drafting.
Why Buyers and Sellers Use Earnouts
A buyer may want an earnout when the business has limited operating history, revenue is growing but not proven, customer concentration is high, a product launch is pending, a major contract may or may not renew, projections are aggressive, or the seller will remain involved after closing — in short, when the buyer wants to reduce upfront risk.
A seller may accept an earnout because it can increase the total purchase price, lets the seller benefit from future growth, may help close the deal, and gives the seller credit for pipeline, goodwill, or revenue that has not landed yet. Earnouts can make sense — but only if both sides understand exactly what they are agreeing to.
Common Earnout Metrics
Earnouts may be based on gross or net revenue, EBITDA, gross profit, customer retention or acquisition, a product launch, regulatory approval, contract renewal, unit sales, subscription revenue (ARR or MRR), store openings, geographic expansion, or clinical, technical, or development milestones.
Each metric has risks. Revenue is easier to measure than EBITDA, but revenue does not account for cost. EBITDA better reflects profitability, but it can be moved by expense allocation, integration decisions, accounting choices, salaries, shared overhead, and other decisions the buyer controls after closing.
The Formula Must Be Precise
The earnout formula should not leave room for guesswork. It should define the measurement period, the maximum earnout amount and any minimum threshold, payment timing, the exact metric and accounting standards, included and excluded revenue, the treatment of refunds, discounts, credits, returns, chargebacks, bad debt, and taxes, the treatment of affiliates and related-party transactions, whether results are measured before or after integration, currency rules, audit and objection rights, and the dispute-resolution process.
The rule of thumb: if the earnout can be interpreted two ways, there is a good chance it will be — by whichever party the second interpretation favors.
Negotiating a deal with an earnout on the table? The formula, control rights, and reporting terms get locked in at signing — not fixed after closing. We help buyers and sellers get the structure right first.
Book a Free Consultation →Buyer Control After Closing Is the Central Tension
After closing, the buyer usually controls the business. The seller may worry that the buyer will reduce marketing spend, change pricing, shift customers to another product line, allocate expenses to depress EBITDA, delay launches, fire key employees, integrate the business in a way that distorts the metrics, or simply operate the business to avoid paying the earnout. The buyer, in turn, may worry that the seller will demand unrealistic operating restrictions, interfere with integration, prioritize short-term earnout metrics over long-term health, or second-guess every reasonable business decision.
The purchase agreement should say what the buyer’s post-closing obligations are — if any. Common approaches include a commercially-reasonable-efforts standard, an ordinary-course operating covenant, budget commitments, a list of specific prohibited actions, or an express statement that there is no operating covenant at all. What matters is that both sides know which one they agreed to.
Seller Protections to Consider
A seller may want defined operating covenants, minimum marketing or sales support, limits on expense allocations, restrictions on diverting revenue, access to books and records, periodic reporting, audit rights, notice of major operational changes, consultation rights, retention of key employees, separate tracking of the acquired business’s performance, acceleration of the earnout if the business is resold or shut down, and a clear dispute-resolution procedure. The stronger the seller’s protections, the harder the buyer will push back on restrictions to its post-closing control — that tension should be negotiated openly, not discovered later.
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Buyer Protections to Consider
A buyer may want a clear earnout cap, no obligation to operate against its business judgment, integration flexibility, the ability to change pricing, staffing, strategy, or products, exclusions for extraordinary items, discretion over budgets, limits on seller interference, non-compete and non-solicitation provisions where enforceable, seller cooperation obligations, offset rights for indemnity claims, and forfeiture or adjustment if the seller breaches post-closing obligations. These protections keep the buyer from being locked into running the acquired business solely to maximize the seller’s earnout.
Buying or selling a business with contingent consideration? The earnout terms deserve the same scrutiny as the headline price. Book an M&A consultation →
Reporting and Audit Rights Matter
Earnout disputes often arise because the seller does not trust the buyer’s calculation — and has no contractual way to check it. The agreement should specify when reports are delivered and what they include, who prepares the calculations, whether supporting schedules are required, whether the seller can access records, how long the seller has to object and what happens if no objection is made, whether an independent accountant decides disputes, who pays the dispute costs, and whether the accountant’s decision is final. A clear reporting and objection process is often the difference between a resolvable disagreement and immediate litigation.
Tax and Purchase Price Allocation Issues
Earnouts raise tax and accounting issues for both sides. The IRS explains that the sale of a business is generally treated as the sale of individual assets, with the consideration allocated among them — see IRS Publication 544 and the Form 4797 instructions. Contingent payments can also implicate installment-sale rules: IRS Topic 705 and Publication 537 address how the selling price may include money, property, certain buyer-paid expenses, and assumed debt.
Depending on structure, an earnout may involve installment reporting, imputed interest, purchase price allocation, ordinary-income-versus-capital-gain questions, compensation characterization (especially if the seller stays employed), contingent payment rules, and Form 8594 reporting. Both parties should involve tax advisors before signing — not at filing time.
Earnouts Are Litigation-Prone When the Drafting Is Loose
Common earnout disputes turn on whether the milestone was met, whether revenue was properly counted, whether EBITDA was calculated correctly, whether expenses were improperly allocated, whether the buyer used the required efforts, whether the seller interfered, whether accounting methods changed, whether customer revenue was diverted, and whether the earnout accelerated after a resale or shutdown.
Federal courts have addressed exactly these fights. Miranda v. U.S. Security Associates, Inc. involved alleged breach of an asset purchase agreement relating to EBITDA calculations and earnout compensation, including good-faith questions about the buyer’s management of the acquired business. Allonhill, LLC v. Stewart Lender Services, Inc. involved claims connected to an asset purchase agreement and its earnout payment provisions after the targets went unmet. The point is simple: when the drafting is loose, the earnout is where the deal ends up in court.
Is the earnout a large share of your purchase price? Then the definitions, covenants, and audit rights are the deal. We review earnout terms before they become the next dispute.
Talk to an M&A Attorney →The Earnout Drafting Checklist
Before signing, buyers and sellers should have addressed: the earnout amount and cap; the metric, measurement period, and payment dates; the accounting method; revenue inclusions and exclusions; expense allocation; buyer operating covenants; seller cooperation obligations; access to records and reporting requirements; objection procedures and the independent-accountant process; offset rights; tax reporting; treatment on resale, shutdown, or integration; treatment if the seller’s employment is terminated; confidentiality; the dispute forum; attorney’s fees; and survival and remedies.
Red Flags That an Earnout Needs Legal Review
Speak with counsel if the formula is based on undefined revenue or EBITDA; the buyer will control the business after closing but the agreement is silent on operating obligations; the seller has no reporting or audit rights; the earnout depends on customer retention, future contracts, a product launch, or regulatory approval; the seller will remain employed or consulting after closing; the buyer wants offset rights against the earnout; there is no dispute-resolution process; tax treatment has not been reviewed; or the earnout represents a large part of the purchase price.
How Accord & Shield Legal Can Help
Accord & Shield Legal helps business buyers, sellers, founders, and investors structure and negotiate sale agreements, including letter-of-intent review, asset and stock purchase agreements, earnout structure and drafting, seller and buyer protections, reporting and audit rights, dispute-resolution provisions, indemnity and escrow coordination, seller consulting or employment agreements, and coordination with tax and accounting advisors. We have seen earnouts close valuation gaps — and we have seen vague earnout language create expensive post-closing conflict. A well-drafted earnout makes the formula, control rights, reporting process, and dispute path clear before closing.
Learn more about our mergers & acquisitions practice, or read our guides to buying or selling a business in Arizona and the tech M&A due diligence checklist.
Frequently Asked Questions
An earnout is a provision that makes part of the purchase price payable after closing if the business meets specified financial, operational, customer, product, or other milestones. It shifts part of the price into the future and ties it to post-closing performance.
Buyers use earnouts to reduce upfront risk when future performance is uncertain, projections are aggressive, customer concentration is high, or buyer and seller disagree about what the business is worth.
Sellers may agree to earnouts to increase the potential total purchase price and to receive value for future growth, customer pipeline, or expected performance the buyer is not willing to pay for upfront.
Ambiguity. If the metric, formula, accounting method, buyer obligations, reporting rights, or dispute process is unclear, the parties may fight after closing — when the buyer controls the business and the numbers.
It depends. Revenue is easier to measure but does not reflect profitability. EBITDA reflects profitability but can be affected by expense allocation, integration choices, and other buyer-controlled decisions. Whichever metric is used, the agreement should define it precisely.
Only if the agreement provides reporting, access, audit, or objection rights. These rights must be negotiated before signing — after closing, the seller typically has no default right to the buyer’s books.
That depends on the agreement. Buyers generally want flexibility to integrate and run the business; sellers may want covenants requiring commercially reasonable efforts or restrictions on actions that could reduce the earnout. The agreement should say which standard applies.
Earnouts can have significant tax consequences, including installment-sale treatment, purchase price allocation, imputed interest, and capital-gain-versus-ordinary-income character issues. Buyers and sellers should consult tax advisors before signing.
This article is provided by Accord & Shield Legal for general informational purposes only. It is not legal advice, does not create an attorney-client relationship, and should not be relied upon as a substitute for advice from a qualified attorney who understands your specific facts, transaction structure, purchase agreement, tax circumstances, and business goals. Tax, accounting, valuation, and financial matters should be reviewed with qualified professionals. Do not send confidential information unless and until an attorney-client relationship has been formally established in writing. Prior results do not guarantee a similar outcome.