An earn-out is often the solution when a buyer and seller cannot agree on price.

The seller believes the business is worth more than what the buyer is willing to pay upfront. So, the parties resolve the issue by deferring the portion of the price they cannot agree on, with payment depending on how the business performs after completion. This bridges the gap and the deal proceeds.

However, what the parties may not realise is that the earn-out may just postpone the disagreement instead of removing it.

The seller’s earn-out depends on how the business performs. However, after completion, the company may be controlled by the buyer instead of the seller. The seller, whose earn-out payment depends on the company’s performance, may no longer be the person making the decisions that drive the performance.

That is the tension at the heart of most earn-out disputes. The buyer integrates the business into its group, changes strategies, invests for the long term, or allocates costs differently. All of these may be reasonable decisions for an owner to make, but they may reduce the earn-out the seller was counting on.

The buyer’s decisions on how to run the company after gaining control may not be made in bad faith. They may simply come from what the agreement failed to pin down before signing:

• How exactly is the performance metric calculated, and on what accounting basis?
• What can and cannot the buyer do with the business during the earn-out period?
• What happens if the two sides disagree on the final figure?

An earn-out bridges a valuation gap. However, it only works if the agreement is precise about how the performance will be measured and how the business will be run after completion of the transaction. If the relevant details are left out from the agreement, the earn-out merely defers the dispute.