Earnouts are everywhere in M&A right now. Valuation gaps between buyers and sellers have widened. Interest rates have made financing harder. So more deals are bridged with deferred consideration tied to future performance.

On paper, earnouts look elegant. Seller gets upside if the business performs. Buyer limits downside if it doesn't. Everyone wins.

In practice, earnouts are one of the most litigated areas of M&A law. They destroy relationships. They unwind deals. They cost both sides far more than the disputed amount.

Here's what you need to know — whether you're sitting on the buy side or the sell side.

What Is an Earnout?

An earnout is a contractual mechanism where part of the purchase price is deferred and paid only if the business hits agreed performance targets after completion.

A typical structure might look like this: £2m paid on day one, with up to a further £1m payable over two years if revenue exceeds £3.5m in Year 1 and EBITDA exceeds 18% in Year 2.

Simple enough in concept. The complexity lies in the detail, and the detail is where deals fall apart.

The Seller's Perspective

 

Why Sellers Accept Earnouts

Usually because they have to. If a buyer can't bridge the valuation gap any other way, an earnout keeps the deal alive.

Sometimes sellers genuinely believe in their own numbers. If you're confident the business will hit its targets, an earnout just delays cash you were going to receive anyway.

Occasionally, earnouts offer a tax advantage by structuring deferred consideration as capital rather than income. Always take specialist tax advice on this.

What Sellers Want

• A short earnout period. Twelve to eighteen months is preferable. Anything beyond three years is rarely worth accepting.
• Simple, objective metrics. Revenue is cleaner than profit. Profit can be manipulated.
• Control over the business during the earnout period. If the buyer can restructure, cut headcount, or redirect customers, your targets become unachievable before the ink is dry.
• A cap on the buyer's ability to change the cost base. If they load the P&L with head office charges or new management fees, your EBITDA targets disappear overnight.
• Accelerated payment on exit. If the buyer sells the business during the earnout period, you should be entitled to immediate payment of the full earnout amount.

The Seller's Core Risk

You no longer control the business. From completion, the buyer is in charge. Even with the best contractual protections, they can make decisions, strategically sensible ones, that happen to destroy your earnout.

They might pivot the sales strategy. Cut a product line. Delay a contract. Hire slowly. None of these need be malicious. The effect on your earnout can be devastating.

 

The Buyer's Perspective

 

Why Buyers Use Earnouts

To manage risk. If a business is heavily dependent on its founder, their relationships, their reputation, their energy, then an earnout keeps them motivated and on the hook.

To bridge a valuation gap without overpaying on day one. If the seller believes the business is worth £5m and the buyer thinks £3.5m, an earnout can bridge £1.5m of that gap.

To defer cash outflow. Particularly relevant for smaller acquirers or those using leveraged structures.

What Buyers Want

• Profit-based metrics, not revenue. Revenue can be inflated. Profit keeps the seller aligned with sustainable growth, not vanity numbers.
• A long earnout period. The longer the period, the more time to absorb integration costs, understand the business, and manage risk.
• Discretion over how the business is run post-completion. Buyers don't want to be contractually locked into someone else's business plan.
• Broad carve-outs for exceptional or one-off items that might inflate earnout payments.

The Buyer's Core Risk

Seller resentment. Nothing poisons a business faster than a founder who believes they've been cheated out of their earnout. They stop selling. They stop caring. Key staff follow.

Even if your legal position is watertight, winning the earnout dispute means you've probably lost the business.

 

What the Case Law Actually Teaches Us

These aren't hypothetical risks. The English courts have produced some genuinely instructive decisions on how earnouts go wrong, and what determines who wins.

Porton Capital Technology Funds v 3M UK Holdings Ltd [2011] EWHC 2895 (Comm)

This is the most significant English earnout case and it repays careful reading from both sides of the table.

3M acquired Acolyte Biomedica,  a company that had developed BacLite, a diagnostic product for detecting MRSA, for £10.4m cash plus an earnout worth up to £41m, based on net sales of BacLite during 2009. The SPA obliged 3M to actively market BacLite, diligently seek regulatory approval in the US, Canada, EU and Australia, and not to cease the business without the sellers' written consent, which was not to be unreasonably withheld.

The product failed clinical trials in the US. 3M stopped pursuing regulatory approval in March 2008. It then asked the sellers to consent to winding up the business, offering just over $1m in compensation. The sellers refused and demanded the full £41m. 3M closed the business anyway. Net sales in 2009: zero.

The court found that 3M had breached its obligation to diligently seek regulatory approval. The word "diligently" was interpreted as meaning with reasonable application, industry and perseverance — not a requirement of reasonable care, but a meaningful obligation nonetheless. 3M had also breached its obligation to actively market BacLite.

On the consent question, the court found the sellers had been entitled to consider their own interests first. Their refusal to consent was not unreasonable. So 3M had breached the SPA and had wrongly shut the business down.

And yet the sellers received just $1.3m from a 24-day trial in which they had claimed $56m. Why? Causation. The court found that BacLite's underlying commercial prospects were extremely poor regardless of 3M's breaches. Even with regulatory approval, the sales in 2009 would have been minimal. The sellers won on liability. They lost on damages.

The lesson for sellers. Winning on breach is worthless if you lose on causation. You must be able to prove that the targets were realistically achievable and that the buyer's conduct caused you to miss them. Maintain contemporaneous evidence throughout the earnout period: sales pipeline data, board papers, market analysis, forecasts. If the buyer is dragging its feet, document it in real time. Don't reconstruct the picture when litigation starts.

The lesson for buyers. The SPA in this case contained a clause expressly stating that 3M was not required to operate its business in a manner that increased earnout payments. That clause did significant protective work throughout the litigation. Buyers should insist on equivalent language. It is not aggressive — it reflects the commercial reality that the buyer is now running the business.

There is a second, darker lesson here too. This case involved a product whose commercial viability was genuinely uncertain. If you are a seller and the earnout is tied entirely to a product or technology that might fail on its own merits, no amount of legal protection will save you if the market doesn't materialise. The earnout structure itself may be the wrong vehicle.

The Oral Variation Trap — Bloom Media / Jaywing plc

In August 2016, the sellers sold shares in Bloom Media (UK) Limited to Jaywing plc under a written SPA. Things evolved post-completion and the parties discussed different commercial arrangements. The sellers claimed that a further oral agreement was reached in January 2018 introducing new conditions for additional earnout payments worth over £1m.

English courts are deeply sceptical of oral variations to written commercial contracts, particularly where the SPA contains an entire agreement clause. These clauses exist precisely to prevent parties from later claiming that a conversation in a coffee shop changed the terms of a professionally negotiated deal. The court's task is to determine what the written contract actually says — not what the parties thought they agreed to over email threads and phone calls eighteen months after completion.

The lesson. If earnout conditions are discussed or renegotiated post-completion, document the outcome immediately in a written variation agreement, properly executed. A follow-up email saying "as discussed" is not enough. The cost of a brief variation agreement is trivial compared to the cost of litigating whether an oral contract was formed.

Invalid Service — The Email That Wasn't Enough (Hughes v CSC Computer Sciences Ltd [2025] EWHC 302 (Comm))

A recent High Court decision is a salutary reminder that notice provisions are not administrative boilerplate. In this case, the buyer was required under the SPA to "submit" its earnout revenue determinations to the sellers. It sent them by email. The sellers challenged the validity of service on the basis that email was not a valid method under the SPA's formal notice provisions.

The court agreed. The words "any notice or other communication" in the notice clause were extremely widely drafted and caught the earnout determinations. Drawing a distinction between formal notices and earnout calculations was, the court found, both impractical and uncommercial.

The buyer argued estoppel for Year 1 — the sellers had engaged with the figures without raising the service point, so they should not be permitted to challenge validity later. That argument succeeded for Year 1. For Year 2 the sellers had challenged validity promptly, so estoppel did not apply. The court ordered specific performance requiring the parties to go through the contractual dispute resolution process.

The lesson for buyers. Before you send any earnout calculation, read the notice clause. Check whether email is a valid method of service. Many SPAs still require physical delivery to a named address or delivery by courier to a specific partner at the seller's law firm. Sending the wrong document in the wrong way to the wrong address can invalidate an entire year's earnout determination and force you into expensive dispute resolution.

The lesson for sellers. If you receive earnout figures that you believe are incorrectly served or methodologically wrong, challenge validity immediately. In writing. To the correct address. Under the correct notice clause. Engaging with the figures without protest — responding with questions, exchanging emails about the numbers — may estop you from challenging service later. Silence is not neutral.

What the English Courts Will and Won't Imply

Unlike Delaware courts, which have been willing to imply a broad duty of good faith into earnout provisions, the English courts take a narrower position.

English law will imply a term that a party must not deliberately act to prevent the other from receiving the benefit of the bargain. What it will not do, without express language, is require a buyer to run the acquired business in any particular way, make decisions with the earnout in mind, or sacrifice commercial judgment for the seller's benefit.

This is the central reason why express operational covenants matter. Courts enforce what parties agreed. They are reluctant to fill gaps with implied obligations that go beyond preventing deliberate frustration. If you want the buyer to maintain headcount, preserve the cost base, or seek regulatory approval then say so in the SPA. If you don't say it, don't assume the court will read it in.

Negotiating Tactics: What Good Looks Like

 

Define the Metric Precisely

Don't just write "revenue." Define what counts as revenue. Does it include VAT? Refunds? Deferred subscription income? Inter-company charges? Related party transactions?

Don't just write "EBITDA." Define exactly which items are added back and which aren't. Agree a specific accounting policy and state that it will be applied consistently throughout the earnout period.

Vague metrics are earnout litigation waiting to happen.

Agree the Accounting Policy in Writing

The SPA should include a specific accounting methodology appendix. It should state that post-completion accounts will be prepared on the same basis as the pre-completion accounts the buyer relied on during due diligence.

If the buyer switches accounting software, changes depreciation policy, or reclassifies cost centres, that shouldn't affect your earnout calculation.

Build in Operational Protections (Sellers)

If you're a seller, push for covenants that restrict the buyer's ability to:

• Increase the cost base materially without consent
• Transfer material contracts or customers out of the earnout entity
• Load the business with management charges or inter-company debt
• Redirect sales pipeline to other group entities
• Make senior hires above an agreed salary threshold without consent

These are standard protections. A buyer who refuses to agree any of them is signalling something.

Set a Ratchet Structure

Rather than a binary hit-or-miss, a ratchet ties payment to performance bands. Hitting 80% of target might pay 50% of the maximum earnout. Hitting 90% pays 75%. Hitting 100% pays in full. Exceeding targets unlocks a super-earnout.

This aligns incentives more effectively than a cliff-edge threshold and reduces the likelihood of disputes at the margins.

Agree the Dispute Resolution Mechanism Upfront

Every earnout should include a clear process for resolving disagreements about the calculation. Typically: seller reviews draft earnout accounts, raises objections within 30 days, parties try to agree within a further 30 days, and failing that, an independent accountant (not either party's auditor) is appointed as expert, not arbitrator.

The expert determination clause should be detailed. Who bears the costs? What information must be disclosed? What is the timeframe? Nail this down before signing.

Traps to Avoid

 

The Trigger Trap

Some earnouts only pay if the business hits its target in every year of the period. Miss Year 1 by 1%, and the entire earnout is lost, even if Year 2 performance is exceptional. Sellers should push for cumulative targets measured over the whole earnout period rather than annual cliff-edges.

The Integration Trap

Buyers sometimes integrate the acquired business into their existing group before the earnout period ends. Customers transfer. Staff transfer. The standalone P&L disappears. Sellers need to ensure the SPA prevents material integration during the earnout period, or provides for deemed achievement of targets if integration is forced.

The Good Leaver Trap

If the seller is also a key employee post-completion, check how the earnout interacts with their service agreement. Some SPA structures tie earnout payment to continued employment. Constructive dismissal, a unilateral role change, or a without-cause termination could wipe out the earnout. Sellers should decouple the earnout from employment wherever possible. These are separate obligations.

The Cash Flow Trap

Buyers sometimes agree earnout structures they genuinely cannot afford to pay if targets are hit. Sellers should consider asking for security — a charge over assets, an escrow arrangement, or a personal guarantee — particularly in leveraged deals. An unsecured earnout claim against an insolvent buyer is worth very little.

The Metric Manipulation Trap

EBITDA-based earnouts are vulnerable to manipulation, lawful manipulation, at that. A buyer can increase depreciation. Accelerate cost recognition. Defer revenue. Reclassify items. None of this needs to be fraudulent. All of it affects your earnout. Revenue is a harder metric to move. If you must accept an EBITDA metric, ensure the accounting policy is locked down and the buyer must seek written consent before any material change to accounting treatment.

What a Win-Win Actually Looks Like

Most earnout commentary focuses on how they go wrong. It's worth being equally clear about what a well-structured earnout looks like when both sides approach it in good faith, because they do work when designed properly.

A genuinely successful earnout has four characteristics.

The earnout bridges a real gap, not a fundamental disagreement. If the buyer thinks the business is worth £3m and the seller thinks it's worth £6m, you don't have a valuation gap,  you have an incompatible worldview. An earnout won't fix that. It will defer the argument. A successful earnout bridges a genuine uncertainty: the business is performing well but has a contract pipeline, product launch, or regulatory approval on the horizon that hasn't yet crystallised into revenue. Both sides believe in the upside. The earnout gives the seller credit if it lands.

The seller retains operational influence. A win-win earnout doesn't ask the seller to hand over the keys on day one and hope for the best. The seller, whether as a retained MD, a consultant, or a non-exec, has a clear role in driving the very performance the earnout measures. Their expertise is part of the asset the buyer acquired. Harnessing it properly protects both sides. The buyer gets continuity. The seller drives their own outcome.

The metric is simple enough that both sides can track it in real time. Monthly revenue reports. Shared access to the management accounts. No surprises at year-end. If both parties know where they stand against target throughout the period, disputes rarely escalate. It's the opacity that breeds suspicion. Transparency costs nothing and preserves the relationship.

The earnout period is short. Twelve to eighteen months is the sweet spot. Long enough to capture meaningful performance. Short enough that both sides remain focused. Beyond two years, priorities diverge. The buyer is thinking about the next phase of the business. The seller is still watching the metric. Misalignment is almost inevitable.

When all four of these conditions are met, an earnout does what it's supposed to do: it gets a deal closed that wouldn't have closed otherwise, and it pays the seller fairly for performance they genuinely delivered.

What Each Side's Lawyers Should Be Doing

Lawyers add the most value in earnout transactions not during the dispute but long before it. Here is what good legal advice looks like on each side.

The Seller's Lawyers

Start at heads of terms. The earnout metric, the earnout period, and the baseline operational protections should all be agreed in principle before lawyers are instructed on the SPA. Once heads of terms are signed, commercial momentum works against the seller. Concessions made at SPA stage are always harder to recover.

Challenge the metric. If the buyer is proposing EBITDA, push back on revenue. If they insist on profit, demand a precisely defined accounting policy appendix with every add-back itemised. Vague metric language is the buyer's friend. Precision is the seller's.

Draft the operational covenants as if the relationship will break down. It may not. But the covenants need to work in the scenario where it does. That means: no material cost base increases without consent, no management charges, no inter-company transfers, no redirection of pipeline, consent required for senior hires above a threshold. Make the protections specific, not aspirational.

Decouple the earnout from employment. If the seller is staying on as an employee or consultant, the service agreement and the SPA should be treated as entirely separate instruments. Earnout payments should not be conditional on employment and should not be capable of forfeiture on termination without cause.

Build in information rights. Monthly management accounts. Quarterly board papers. Access to the finance team. A right to commission an independent review of the earnout calculations. Without information rights, the seller is flying blind. And as the service of notices case demonstrates, the right to challenge figures means nothing if you don't have the information to challenge them with.

Negotiate the dispute resolution clause in detail. Who appoints the independent expert? Under what procedure? Within what timeframe? Who bears the cost? What information must the buyer disclose? A skeletal dispute resolution clause is almost useless if the parties can't agree on an expert. Specify the appointing body (ICAEW is standard), the disclosure obligations, and the timeline. A detailed clause costs an hour of drafting time. The absence of one can cost months of litigation.

Advise on estoppel risk from day one. Once the earnout period starts, every communication between the parties has potential legal significance. Sellers should be advised not to engage substantively with earnout calculations they believe are wrongly served or incorrectly calculated without first reserving their position in writing.

The Buyer's Lawyers

Include the "no obligation to maximise" clause. This is non-negotiable. The SPA should expressly state that the buyer is not obliged to operate the business in a manner designed to maximise earnout payments. The Porton Capital case demonstrates how much work this language can do. Without it, the buyer faces implied obligation arguments every time it makes a decision the seller doesn't like.

Define the limits of the operational covenants. Sellers will push for broad restrictions. Buyers should push back with precision. "No material increase in the cost base without consent" is reasonable. What counts as material? Define it. A threshold expressed in pounds, say, £50,000 per annum, is more defensible than a concept that the parties will argue over.

Lock down the notice provisions. This is basic hygiene that is too often ignored. Before the earnout period starts, confirm in writing the correct address, correct named recipient, and correct method of service for all earnout communications. Serve every earnout calculation correctly and keep evidence of service. The 2025 High Court case, where earnout figures sent by email were invalidated, is a reminder that procedural failures have substantive consequences.

Keep meticulous records of business decisions. Every decision that could affect the earnout, a cost increase, a personnel change, a strategic pivot, should be documented at board level with a contemporaneous business rationale. If litigation comes, the buyer needs to show that its decisions were commercially driven and taken without reference to the earnout. Well-kept board minutes are powerful evidence. A reconstructed narrative is not.

Treat the seller's information rights as an investment, not a concession. Buyers who drip-feed information create the suspicion that they have something to hide. Buyers who provide transparent monthly reporting, ideally in a format agreed at completion, reduce the temperature of the earnout period significantly. A founder who can see that the business is on track has nothing to litigate about. A founder who can't see the numbers will assume the worst.

Consider escrow as a tool, not just a seller protection. Buyers sometimes resist escrow on the grounds that it ties up capital. But a properly structured escrow account, holding the maximum earnout amount, can also protect the buyer. It evidences the buyer's ability and intention to pay if targets are hit, it reduces the seller's security concerns, and it can be a lever in negotiations. A seller who knows the money is sitting in escrow is less likely to litigate.

When Earnouts Work (And When They Don't)

Earnouts work best when the period is short, the metric is simple and objective, the seller retains operational influence, both parties have negotiated in good faith, and the disputed sum is material enough to sustain motivation but not so large it becomes adversarial.

Earnouts work worst when the valuation gap is so large the earnout becomes the main event, the seller is sidelined post-completion, the metric is profit-based with no accounting policy lock, the buyer is integrating aggressively, or the relationship between buyer and seller breaks down early.

The honest truth is this: if you need a £3m earnout to get a £6m deal done, you probably have a fundamental disagreement about what the business is worth. Sometimes that cannot be bridged with deferred consideration. Sometimes the right answer is to walk away.

 

Final Thought

Earnouts are a tool, not a solution. Used well, they get deals done that wouldn't otherwise close and align both parties behind post-completion performance.

Used badly, they defer and amplify conflict that was always going to come.

If you're heading into an earnout negotiation — on either side — get specialist M&A legal advice early. Not after heads of terms are signed. Before them. The metric, the accounting policy, and the operational protections need to be agreed at term sheet stage, not argued about in the SPA.

By that point, commercial momentum is against you, and you'll give too much away.

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The team at Impact Lawyers advises buyers and sellers on M&A transactions, including earnout structuring, negotiation, and dispute resolution. If you're preparing for a transaction or navigating an earnout dispute, get in touch with Kevin Withane at kevin.withane@impactlawyers.co.uk.