An earnout solves one M&A problem and creates another. The problem it solves: the buyer will not pay the seller’s projections in cash up front, and the seller will not sell at the buyer’s lower number. So the seller takes some money now plus the right to more if the business hits agreed metrics after closing.
The problem it creates is structural, and it is the reason this page exists. The buyer runs the business during the earnout period and only pays out if the metrics are met. The buyer wants those payments small. The seller wants them large. And the buyer holds the controls. The stretch between closing and the final earnout calculation is where that conflict turns into litigation.
The structure
Typical earnout structures share several features:
Metric. The financial measure that determines payouts. Revenue, EBITDA, gross profit, and adjusted variants are common. Sometimes operating metrics (customer counts, specific product sales) are used.
Measurement period. Usually one to three years post-closing, often divided into annual sub-periods with intermediate payouts.
Calculation methodology. Specific accounting principles and definitions applied to the metric calculation. Often appended as exhibits with substantial detail.
Payment terms. When and how payments are made when earned. Sometimes tied to specific thresholds; sometimes linear above thresholds.
Caps and floors. Maximum potential earnout; sometimes minimum payments regardless of performance.
Acceleration provisions. Circumstances triggering acceleration (change of control, termination of seller employment, specific buyer breaches).
Dispute resolution. Independent accountant procedures, arbitration, or litigation for resolving disputes.
The negotiation of these features happens at the deal stage and substantially affects the dispute risk profile. Cases involving carefully drafted earnouts typically resolve more quickly than cases involving loose drafting.
Common dispute categories
Calculation disputes. The buyer calculates the earnout metric in ways the seller disputes. Common subcategories:
- Revenue recognition timing. When specific revenues are recognized for earnout purposes.
- Expense allocation. Allocation of buyer overhead, shared services, or other costs to the target business.
- Adjustments and add-backs. Whether specific items should be excluded from or included in the calculation.
- Accounting policy changes. Whether the buyer has applied different accounting policies than were applied pre-closing.
- One-time items. Treatment of non-recurring revenues or expenses.
- Currency and consolidation issues. For international acquisitions.
Operational conduct disputes. Even when the calculation methodology is not disputed, the buyer’s operational conduct affects the underlying performance. Common allegations:
- Customer reallocation. Customers being moved from the target to other buyer business units.
- Resource starvation. Investment and resource allocation away from the target.
- Talent diversion. Key personnel being moved away from the target.
- Strategic redirection. The target being pushed into less profitable lines or away from previously profitable ones.
- Pricing changes. Pricing decisions affecting margin metrics.
- Termination of seller employment. When the seller was expected to manage the target, premature termination affects performance.
Sandbagging and anti-sandbagging. Disputes about whether buyer knowledge of pre-closing issues affects post-closing claims. Pro-sandbagging clauses allow buyers to assert claims even when they knew of the issue; anti- sandbagging clauses limit claims to issues the buyer did not know about.
Acceleration disputes. Whether specific events trigger acceleration of unpaid earnout, particularly in acquisition scenarios where the original buyer is themselves acquired.
Information rights disputes. Buyer obligations to provide the seller with information needed to evaluate performance and earnout calculations. Sellers often need substantial information to assess whether the calculations are accurate.
Buyer good faith and operational covenants
The central legal question in many Texas earnout disputes is whether the buyer has any duty to operate the business in ways that allow legitimate earnout achievement.
Texas courts have generally been reluctant to imply duties of good faith in commercial M&A contexts. The contract governs, and absent express provisions, the buyer has substantial operational discretion.
But express covenants, when they exist, are enforceable:
Specific operational covenants. “Buyer shall not materially change the business operations of the target.”
Best efforts or commercially reasonable efforts covenants. “Buyer shall use commercially reasonable efforts to achieve the earnout metric.”
No-frustration covenants. “Buyer shall not take action intended to frustrate the seller’s ability to achieve the earnout.”
Specific prohibitions. Specific restrictions on the buyer’s ability to reallocate customers, change accounting methods, divert resources, etc.
Cases turn substantially on the specific language negotiated. Sellers with strong operational covenants have substantial protection; sellers without them often have limited recovery options regardless of buyer conduct.
Some agreements expressly disclaim any duty. These provisions are typically enforceable but their scope can be disputed, particularly when the buyer’s conduct goes beyond ordinary business decisions and approaches deliberate frustration of the earnout.
Fraud claims
Beyond ordinary breach claims, earnout disputes sometimes support fraud theories:
Pre-closing fraud. Misrepresentations during diligence about the target’s performance trajectory, customer pipeline, or other matters that affect the earnout.
Closing-time fraud. Misrepresentations at closing about the buyer’s intentions for the business.
Post-closing fraud. Misrepresentations to the seller during the earnout period about the buyer’s operational intentions or actual performance.
Fraud claims expand the available remedies (exemplary damages, broader damages calculations) and override contractual limitations that would otherwise apply. See Fraud and Fraudulent Inducement.
Strategic considerations
For sellers pursuing earnout claims:
Document the operational conduct. The buyer’s actions during the earnout period are central to most cases. Internal communications, decision documents, and the operational record become essential.
Engage forensic accounting expertise. Calculation disputes require specialized accounting analysis.
Address the contractual procedures. Notice requirements, dispute resolution mechanisms, and other procedural provisions must be observed.
Coordinate breach and fraud theories. When fraud applies, pleading both theories preserves the expanded remedies.
Prepare for the long arc. Earnout cases often run through the full earnout period before resolution. The timeline shapes strategy.
For buyers defending earnout claims:
Enforce contractual provisions. No-implied-covenant provisions, dispute resolution procedures, calculation methodologies must all be invoked.
Develop the business-judgment narrative. Operational decisions reflecting legitimate business judgment defeat breach claims.
Challenge the calculation methodology. Many seller calculations are vulnerable on methodology grounds.
Coordinate with insurance coverage. Some buyer policies cover earnout-related claims; others do not.
Two fronts: the math and the covenant
Earnout disputes are fought on two fronts, and we work both. The first is the calculation, so we engage forensic accountants early, because the math is central and qualified support shapes the whole case. The second is the contract language, where the operational covenants live, and the analysis starts with a detailed read of those provisions. Where the buyer’s conduct crosses from hard bargaining into something worse, we pair breach with fraud, since the expanded remedies often beat a contract-only case. We take either side, buyer or seller, on the same framework.
Sellers protect themselves at the drafting table, not in court. If you are already in the dispute, the covenants you negotiated are the case. We start there.
Frequently Asked Questions
What is an earnout in a Texas M&A transaction?
An earnout is a portion of the purchase price that is paid contingent on the acquired business achieving specific performance metrics after closing. Typical earnouts pay out over a defined period (often one to three years) based on the target's revenue, EBITDA, gross profit, or other agreed metrics. Earnouts are used when the buyer and seller cannot agree on a fixed valuation reflecting the target's future performance, the earnout effectively shifts some of the valuation risk based on actual results.
Why are earnouts a common source of M&A litigation?
Because the buyer controls the business during the earnout period and the seller is typically a passive recipient of the payments, the structure creates inherent conflicts of interest. Buyers may operate the business in ways that minimize the earnout payments, reallocating customers, changing accounting methods, deferring revenue, allocating expenses, integrating the target with the buyer in ways that affect performance metrics. Sellers may believe the metrics they negotiated were not honored. Most earnouts produce some level of friction; substantial earnouts often produce litigation.
Does a Texas buyer have a duty of good faith in operating the business during the earnout period?
It depends on the agreement. Some Texas M&A agreements include express good-faith or commercially-reasonable-efforts covenants requiring the buyer to operate the business in ways that allow legitimate earnout achievement. Other agreements expressly disclaim any such duty, giving the buyer broad operational discretion. Without an express covenant, Texas courts have generally been reluctant to imply good-faith duties in commercial M&A contexts. The contract language largely controls. Seller protection requires negotiating express operational covenants in the original agreement.