When Earnouts Go Wrong - Navigating Post-Acquisition Disputes Over Contingent Payments

You signed the deal, celebrated the close, and started planning your next chapter. Then the first earnout period ended, and everything fell apart. The buyer’s calculation showed you missed your targets by a significant margin. Your numbers showed you exceeded them. Now you’re staring at a substantial gap between what you expected and what you’re being offered, wondering how a “successful” exit turned into a legal quagmire. This scenario plays out regularly in middle-market transactions, and understanding how to handle it can mean the difference between recovering your expected value and walking away with far less.

Executive Summary

Earnout disputes represent one of the most common, and emotionally draining, challenges facing business owners after selling their companies. These contingent payment arrangements create fertile ground for disagreement when sellers and buyers interpret targets, calculations, and performance metrics differently.

This article examines the primary causes of earnout disputes, from definitional ambiguities in purchase agreements to buyer operational decisions that affect earnout metrics. We analyze the most contentious calculation issues, including EBITDA adjustments, revenue recognition timing, and expense allocation between corporate and acquired entities.

More importantly, we provide practical frameworks for managing earnout conflicts when they arise. This includes understanding your contractual dispute resolution mechanisms, building documentation practices that support your position, and making economically informed decisions about when to escalate versus when to negotiate. We also address the human element: maintaining professional relationships with buyers who are now also adversaries in a financial dispute.

This article addresses earnout disputes in US middle-market transactions under US law. Earnout dispute resolution varies significantly by jurisdiction, governing law, and country. If your earnout is subject to non-US law or involves cross-border elements, consult advisors familiar with the applicable jurisdiction.

Whether you’re currently handling an earnout disagreement or structuring a deal that includes contingent payments, understanding these dispute patterns helps you protect significant value that might otherwise evaporate through ambiguity, miscommunication, or buyer decisions that work against your interests.

Introduction

Industry practitioners and deal advisors report that earnouts have become increasingly common in middle-market transactions, particularly in deals valued between $5 million and $50 million. Buyers use them to bridge valuation gaps, mitigate risk, and align seller incentives with post-close performance. Sellers accept them because earnouts often allow higher total deal values than all-cash alternatives, and because walking away from a deal over earnout terms feels like leaving money on the table.

The problem is that earnouts contain inherent tensions. Once the deal closes, the buyer controls the business. They make operating decisions, set budgets, allocate resources, and determine how performance metrics get measured. Meanwhile, the seller, who no longer has operational authority, watches from the sidelines, hoping the buyer runs the business in ways that trigger earnout payments.

This structural imbalance explains why earnout disputes are common post-close challenges. While earnout disputes are frequent among deals that experience disagreement, many earnout arrangements execute as intended without material conflict. This article focuses on disputes when they arise, but many business owners complete earnout periods without significant disagreement. Understanding common dispute patterns helps prevent problems, but doesn’t suggest earnout disputes are inevitable.

The earnout dispute patterns discussed here are drawn from our experience advising sellers handling earnout disputes, combined with publicly available case law and industry research on contingent payment conflicts. The cases we’ve guided clients through likely represent the more complex or contentious disputes: those serious enough to require external advisors. Many earnout disagreements resolve quickly through buyer-seller negotiation without external escalation. The patterns discussed here represent common issues in disputes that escalated, not necessarily the distribution across all earnout disagreements.

Understanding these dynamics before you sign becomes your first line of defense. But even after closing, knowledge of common dispute patterns and resolution strategies gives you meaningful leverage when disagreements arise.

Common Causes of Earnout Disputes

Definitional Ambiguity in Purchase Agreements

The most preventable category of earnout disputes stems from imprecise language in the purchase agreement itself. Definitional ambiguity creates fertile ground for disputes by allowing multiple reasonable interpretations. Precise language prevents disputes caused by innocent misalignment of understanding, though disputes can arise from precise agreements when parties interpret performance metrics or calculation methodology differently.

Consider a scenario where your earnout is tied to “EBITDA as calculated in accordance with GAAP.” This sounds precise until you realize that GAAP permits multiple approaches for recognizing revenue, capitalizing expenses, and allocating costs. The buyer’s CFO applies GAAP consistently with their corporate practices. You applied GAAP consistently with how you ran the business pre-close. Both interpretations are technically defensible, but they produce materially different results.

In larger transactions (typically above $25 million) and PE-backed acquisitions, earnouts are frequently tied to EBITDA metrics. For service businesses, professional services firms, and smaller deals, revenue-based or customer-retention earnouts are more typical. Technology and SaaS companies often see recurring revenue or net revenue retention metrics, while healthcare and manufacturing businesses may use patient volume or production-based measures. The specific metric your agreement uses determines which definitional issues matter most.

Common definitional issues that generate earnout disputes include:

Revenue Recognition Timing: When does a sale count: at contract signing, delivery, payment receipt, or some other trigger? In businesses with long sales cycles, recurring revenue, or complex contract terms (SaaS, professional services, enterprise software), revenue recognition timing becomes a critical dispute source. In cash-based businesses with immediate recognition, this is typically not contentious.

Expense Allocation: Post-acquisition, the buyer may allocate corporate overhead, shared service costs, or management fees to your business unit. If the purchase agreement doesn’t address how these allocations affect earnout calculations, disputes become likely.

Customer and Contract Definitions: Earnouts tied to customer retention or contract renewals require precise definitions of what constitutes a “customer” and when a relationship is considered “retained.” Buyers and sellers often discover post-close that they interpreted these terms differently.

Adjustments and Exclusions: EBITDA-based earnouts typically include language about “normalized” or “adjusted” EBITDA. The adjustments that seemed reasonable during negotiations (extraordinary items, one-time costs, owner-specific expenses) become battlegrounds when applied to actual post-close financials.

Buyer Operational Decisions and Their Impact

Perhaps the most frustrating category of earnout disputes involves buyer actions that affect the seller’s ability to achieve targets. Once the buyer controls the business, they can make decisions that reduce earnout metrics even when those decisions are commercially rational from the buyer’s perspective.

It’s critical to distinguish between different categories of buyer behavior:

Legitimate business decisions: The buyer makes a strategic pivot that affects earnout metrics, but it’s a reasonable business decision that a reasonable buyer could make. Many purchase agreements explicitly permit these.

Gross negligence: The buyer fails to operate the business competently, causing metric deterioration through incompetence rather than strategy.

Deliberate interference: The buyer intentionally undermines earnout achievement to avoid payment.

These categories have vastly different contractual implications, remedies, and litigation prospects. Purchase agreements vary significantly in limiting buyer discretion. Some require “good faith” operations or operations “consistent with past practices,” which restrict major changes. Others grant buyers broad discretion to make business decisions, even if those decisions reduce earnout metrics. Your contract’s language determines whether specific buyer actions are actionable.

Common patterns that affect earnout metrics include:

Resource Reallocation: The buyer redirects sales staff, marketing budgets, or technical resources away from the acquired business to support other priorities. When a buyer reallocates resources away from the acquired business, it becomes harder to hit targets, but the buyer will argue the resource reduction was strategic optimization and doesn’t excuse targets. Proving that resource reallocation caused target failure requires showing that comparable performance was achievable with the reallocated resources: a complex proof requiring detailed analysis.

Pricing and Product Changes: The buyer modifies pricing strategies, discontinues products, or changes service offerings in ways that affect earnout metrics. They may argue these changes serve long-term strategy, but the short-term impact falls on your contingent payments.

Customer Diversion: In acquisitions where the buyer had existing customer relationships, they may steer business toward legacy products or services rather than the acquired offerings, reducing your customer-based metrics while growing their overall revenue.

Personnel Decisions: Key employees critical to achieving earnout targets may be reassigned, terminated, or promoted to other divisions within the buyer organization.

Important caveat on interference claims: Buyer interference claims are difficult to prove. You must establish not just that buyer actions negatively affected earnout metrics, but that buyer actions caused the specific shortfall, distinguished from market conditions, competitive pressure, or other factors. Additionally, many contracts explicitly permit buyers to make business decisions, even decisions that reduce earnout metrics. Before investing heavily in interference claims, consult advisors about the specific causation you can establish with evidence. Interference claims typically have significant costs and uncertain outcomes.

Calculation Methodology Disputes

Even when purchase agreements contain detailed earnout definitions, the actual calculation process creates opportunities for disagreement. Buyers control the books post-close, and their accounting practices may differ from seller expectations.

Changes in Accounting Policies: If the buyer applies different accounting policies than you used pre-close, EBITDA and revenue figures may shift. While most purchase agreements require consistent methodology, “consistent” is itself a term requiring interpretation.

Timing of Expense Recognition: Buyers may accelerate expense recognition or defer revenue recognition in ways that reduce earnout-period performance. Whether these timing decisions represent normal business practice or manipulation depends heavily on context and evidence.

Intercompany Transactions: Post-acquisition, your former business may engage in transactions with other buyer entities: purchasing supplies, sharing facilities, or transferring personnel. The pricing and accounting treatment of these intercompany dealings directly affect earnout metrics.

Period-End Adjustments: Year-end or period-end accounting adjustments can materially affect earnout calculations. Reserve adjustments, accrual true-ups, and audit adjustments may differ from what you observed in your own financial close processes.

Dispute Resolution Mechanisms

Contractual Escalation Processes

Most well-drafted purchase agreements include specific procedures for resolving earnout calculation disputes. Understanding and following these procedures precisely is critical: courts have dismissed seller claims when sellers failed to comply with contractual notice requirements or escalation timelines.

A note on notice deadlines: Check your purchase agreement regarding notice deadlines and consequences of missing them. Many agreements allow waiver of strict notice requirements if the other party doesn’t object. Others require strict compliance. Missing deadlines creates risk, but whether it constitutes permanent loss of rights depends on your specific agreement and jurisdiction. Don’t assume. Verify with your agreement and advisors.

Typical dispute resolution sequences include:

Notice and Objection: Sellers receive earnout calculations from buyers and have a specified period to submit written objections. In our experience advising on earnout disputes, notice periods typically range from 15 to 90 days depending on how purchase agreements are negotiated. Check your specific agreement immediately: missing notice windows creates waiver risk in many agreements.

Good Faith Negotiation: Most agreements require a negotiation period before escalating to formal dispute resolution. This period is typically procedural; meaningful movement is rare unless one party has evidently misunderstood the other’s position. Use this period to clarify positions and ensure you’re not leaving easily-resolved calculation errors on the table, but don’t invest disproportionate time expecting major concessions.

Accounting Determination: Many agreements designate an independent accountant to resolve calculation disputes. Agreements vary widely on dispute resolution accountants, ranging from major accounting firms (appropriate for large disputes) to regional accounting firms or industry specialists. Understand who your agreement designates and their experience with earnout calculations.

Accounting determination appears objective but involves interpretation of contract language and judgment about which accounting methods to apply. When you understand the area of disagreement before designation, you may discover that reasonable interpretation could go either way, making the specific accountant’s judgment critical. Ensure your accounting determination provision gives you meaningful input on accountant selection or requires specific experience.

Many accounting determinations apply “baseball arbitration”: choosing between the buyer’s and seller’s position rather than splitting the difference. This theoretically encourages moderate positions by penalizing extreme positions. In practice, sophisticated parties anticipate accountant tendencies and calibrate their positions accordingly. While this still moderates extreme positions compared to conventional arbitration, don’t assume it prevents all aggressive positioning.

Arbitration or Litigation: If accounting determinations don’t resolve the dispute, or if issues involve interpretation rather than calculation, formal dispute resolution proceedings may become necessary.

Comparing Dispute Resolution Methods

Before deciding how to resolve your dispute, understand the tradeoffs between resolution methods. The following estimates are based on our firm’s experience advising on earnout disputes over the past decade. Your actual costs and timelines may vary based on dispute complexity, geographic location, and specific circumstances:

*Estimates based on our firm’s experience with middle-market earnout disputes. Complex disputes involving multiple issues, extensive discovery, or appeals may exceed these ranges significantly. Indirect costs (executive time, opportunity cost, relationship damage) can add substantially to total expense.

Building Your Evidentiary Record

When earnout disputes escalate, the party with better documentation typically holds a stronger position. Start building your record immediately upon closing: don’t wait until disagreements emerge.

Pre-Close Documentation: Preserve all negotiation records, including emails, draft agreements, and notes from meetings where earnout terms were discussed. These materials may establish what parties intended when they agreed to specific language.

Operating Metrics Tracking: Maintain your own tracking of earnout-relevant metrics, even if you no longer have direct access to the company’s books. Customer lists, sales pipeline data, and key performance indicators you can independently verify create a baseline for comparison against buyer calculations.

Buyer Communications: Document all interactions with buyer representatives regarding business operations. When they reallocate resources, change strategies, or modify personnel, create contemporaneous records of what happened and how it affected earnout-relevant metrics.

Documentation caution: If you’re employed by the buyer, extensive documentation efforts should appear as routine business practice (copying yourself on emails, maintaining performance metrics) rather than obviously adversarial records. Creating extensive contemporaneous documentation specifically focused on buyer “interference” may damage working relationships and could create evidence issues if litigation ensues. Discuss documentation strategy with your advisor before creating extensive records.

Financial Statement Requests: Most purchase agreements entitle sellers to periodic financial information about the acquired business. Exercise these rights consistently, and note when buyers delay, obstruct, or fail to provide complete information.

Expert Retention Considerations: Forensic accountants are particularly valuable when calculation errors are technical and mathematically demonstrable (e.g., misapplied revenue recognition rules where GAAP applies clearly). They’re less effective when disagreements involve business judgment (e.g., whether a customer should be counted as “retained” under ambiguous contract language) or interpretation where reasonable people disagree. Understand your specific issue before retaining forensic experience.

Early expert engagement makes economic sense when disputed amount exceeds approximately $200K and dispute involves complex calculations. For smaller disputes or straightforward calculation errors, expert engagement may cost more than the value in dispute. Consider dispute size and complexity before reflexively retaining experts.

The “Do Nothing” Alternative

Sometimes accepting the buyer’s calculation is economically rational. If dispute amount is relatively modest and you’d incur substantial costs to pursue it, consider whether vindication is worth the expense. Document your position for tax purposes, but accept the resolution rather than escalating.

The decision framework below helps you evaluate when to pursue disputes versus when to concede.

Making Economically Informed Settlement Decisions

Not every earnout dispute requires escalation to formal proceedings. Negotiated resolutions often preserve more value for both parties, particularly when ongoing relationships matter.

Decision Framework for Settlement vs. Formal Proceedings:

Before deciding between settlement and formal proceedings, calculate expected value:

• Expected value of fighting = (Probability of full recovery × Claimed amount) - (Litigation/expert costs)
• Expected value of settlement = Settlement offer amount
• Decision rule: If expected value of fighting exceeds settlement value by a meaningful margin (e.g., 20%+), consider formal proceedings. If settlement value exceeds expected value of fighting, settlement likely presents better economics.

Example calculation:

Consider a $400K earnout dispute with these parameters:

• Probability of full recovery: 40%
• Estimated litigation and expert costs: $150K
• Settlement offer: 70% of claimed amount ($280K)

Expected value of fighting: (40% × $400K) - $150K = $160K - $150K = $10K expected value after costs

Settlement value: $280K

In this case, settlement presents dramatically better economics ($280K vs. $10K expected value from fighting), even though you believe your full claim is justified.

Different parameters change the analysis:

Consider a $1M earnout dispute:

• Probability of full recovery: 70%
• Estimated litigation and expert costs: $200K
• Settlement offer: 50% of claimed amount ($500K)

Expected value of fighting: (70% × $1M) - $200K = $700K - $200K = $500K expected value after costs

Settlement value: $500K

Here, the expected values are roughly equal: the decision depends on risk tolerance, timeline preferences, and non-financial factors.

Key negotiation principles:

Quantify Your Position Early: Before engaging with the buyer, understand precisely what you believe you’re owed and why. Vague complaints about “unfair” treatment rarely produce results. Specific dollar figures with supporting calculations command attention.

Identify Buyer Motivations: Understanding what the buyer values (beyond simply minimizing earnout payments) can reveal negotiation opportunities. They may prefer structured settlements over lump-sum payments, or accept non-financial consideration in lieu of disputed amounts.

Consider Total Relationship Value: If you remain involved with the business, have other commercial relationships with the buyer, or anticipate future interactions, factor these into your approach.

Evaluate Tax Implications: Settlement of earnout disputes has potential tax implications that differ from original purchase price allocation. Ensure any earnout settlement contemplates tax treatment and consult with your tax advisor before finalizing resolution. The after-tax cost of settlement may differ substantially from the gross amount received.

Maintain Professional Tone: Emotional responses to earnout disputes are understandable: you’re watching expected money disappear. But accusatory communications rarely help. Focus on facts, contractual provisions, and legitimate disagreements rather than impugning buyer motives.

The Role of Continued Employment and Consulting

Many earnout arrangements coincide with seller employment or consulting agreements. When you’re simultaneously an employee and a contingent payment recipient, conflicts become more complex.

Information Access: Continued involvement provides direct access to operational and financial information, making it easier to monitor earnout performance. Use this access appropriately: gathering information you’re entitled to while respecting confidentiality obligations.

Relationship Management: Working for the buyer while disputing earnout calculations creates obvious tensions. Some sellers compartmentalize these roles effectively; others find the dual relationship untenable. Consider how disputes will affect your daily working environment.

Termination Implications: If buyer-seller relationships deteriorate during earnout disputes, termination of employment or consulting arrangements may follow. Understand how termination affects your earnout rights: some agreements tie payment to continued involvement, while others separate employment from contingent payment entitlements.

Documentation Challenges: Materials you access as an employee may be subject to confidentiality restrictions that limit their use in disputes. Understand what you can and cannot use before collecting evidence.

Preventing Disputes Through Better Deal Structure

While this article focuses on handling disputes after they arise, prevention remains the superior strategy. Detailed definitions reduce dispute probability and severity by clarifying intent. They do not eliminate disputes entirely: even clearly defined terms require interpretation in novel scenarios. View detailed definitions as necessary but not sufficient. Pair them with clear dispute resolution procedures and specific operational covenants limiting buyer discretion.

Sellers negotiating earnout terms should prioritize:

Objective, Verifiable Metrics: Tie earnouts to metrics that external parties can verify independently, with minimal room for interpretation. Revenue recognized under specific customer contracts, for example, is more verifiable than “adjusted EBITDA.”

Detailed Definitions: Define every term that affects calculation. Don’t assume shared understanding of accounting concepts or business terminology. The more specific your definitions, the less room for dispute.

Specific Operational Covenants: Good faith and “consistent with past practices” covenants provide some protection, but their enforceability varies by jurisdiction and depends on how courts interpret these elastic terms. Stronger seller protection comes from specific operational covenants: “Maintain minimum sales team headcount of X,” “Maintain annual marketing spend at not less than Y% of revenue,” “Retain key employees [list names] in roles supporting earnout achievement.” Specific numeric commitments are far more enforceable than elastic “good faith” language alone. Pair general good faith provisions with specific commitments.

Audit and Inspection Rights: Ensure you retain meaningful access to financial information and the right to audit earnout calculations at your expense.

Dispute Resolution Clarity: Specify exactly how disputes will be resolved, who bears costs, and what standards decision-makers will apply. Include provisions for accountant selection that give you meaningful input. Ambiguity in dispute resolution provisions creates disputes about disputes.

Actionable Takeaways

For Current Dispute Management:

1. Review your purchase agreement immediately: understand your contractual rights, notice requirements, and dispute resolution procedures before taking any action. In our experience, notice deadlines typically range from 15 to 90 days, and missing them creates waiver risk in many agreements.

2. Calculate the economics before deciding your approach: use the expected value framework: (Win probability × Claimed amount) - Costs vs. Settlement offer. Let the math, not emotion, drive your decision.

3. Engage professional advisors strategically: for disputes exceeding $200K with complex calculation issues, early expert engagement often makes sense. For smaller or straightforward disputes, the costs may exceed the benefit.

4. Document appropriately: create written records of buyer communications and operational decisions, but do so in ways that appear as routine business practice rather than adversarial preparation if you remain employed by the buyer.

5. Consider the “do nothing” alternative: for modest disputes where costs of pursuit exceed the disputed amount, accepting the buyer’s position may be the rational choice.

For Future Deal Structuring:

1. Invest in definitional precision: every ambiguous term in an earnout provision is a potential dispute source. But recognize that definitions reduce rather than eliminate disputes.

2. Negotiate specific operational commitments: general “good faith” language provides less protection than specific covenants regarding headcount, budgets, key employee retention, and resource allocation. Pair general language with numeric commitments.

3. Secure strong information rights: you cannot effectively monitor earnout performance without access to relevant financial and operational data.

4. Ensure meaningful input on dispute resolution accountants: the accountant’s judgment often determines outcomes in calculation disputes.

5. Understand tax implications upfront: structure earnout and potential settlement terms with tax treatment in mind.

Conclusion

Earnout disputes arise from the structural tension between seller payment expectations and buyer operational control. Understanding common dispute patterns (definitional ambiguity, buyer operational decisions that affect metrics, and calculation methodology conflicts) helps sellers anticipate problems before they escalate.

When earnout disputes do arise, success depends on preparation, documentation, and economically informed decision-making. Know your contractual rights, build your evidentiary record appropriately, and evaluate your options with clear-eyed assessment of costs, probabilities, and expected values. Some disputes merit aggressive pursuit; others resolve best through pragmatic negotiation or acceptance.

Most importantly, recognize that the best time to address earnout disputes is before closing: through purchase agreement provisions that leave less room for disagreement and include specific operational protections. Working with experienced advisors during deal negotiation can prevent the painful disputes that too many sellers experience post-close.

If you’re handling an earnout disagreement or structuring a deal with contingent payments, we encourage you to consult with M&A professionals who understand these dynamics. The value at stake, often representing years of business building, deserves informed, strategic protection.