What Is an Earnout in an M&A Deal?

An earnout is a part of the purchase price in a business sale that the buyer pays only if the business hits agreed targets after closing, such as a revenue level, a sales figure or a regulatory approval. The seller takes less cash at closing in exchange for the chance of more later. Earnouts help close a gap when buyer and seller disagree about what the business is worth, but they often lead to disputes because the buyer usually controls the business that has to hit the targets. In Delaware, courts generally enforce the earnout terms as written: a seller is protected by what the contract says, such as an efforts clause or a ban on acting to avoid the payment, and courts rarely add protections the parties didn't negotiate. Other states' law can differ, and the details of each contract decide each case.

At a glance

Sources: Delaware Supreme Court and Court of Chancery opinions cited below, checked Oct. 28, 2026.

Why buyers and sellers use earnouts

Delaware's Court of Chancery explained it this way in Airborne Health v. Squid Soap (2009): an earnout "typically reflects" a "disagreement over the value of the business that is bridged when the seller trades the certainty of less cash at closing for the prospect of more cash over time." In theory, the court said, "the earn-out solves the disagreement over value by requiring the buyer to pay more only if the business proves that it is worth more." The same opinion gave the warning that follows earnouts everywhere: "since value is frequently debatable and the causes of underperformance equally so, an earn-out often converts today's disagreement over price into tomorrow's litigation over the outcome."

Real deals show how large the contingent part can be:

• In Squid Soap, the seller agreed to $1 million in cash at closing plus potential earnout payments of up to $26.5 million.
• In Lazard v. Qinetiq (Del. 2015), the buyer paid $40 million up front and promised up to another $40 million if the company's revenues reached a certain level.
• In Johnson & Johnson v. Fortis Advisors (Del. 2026), J&J paid $3.4 billion in upfront cash for Auris Health, plus up to $2.35 billion in earnouts tied to ten milestones: eight regulatory milestones and two net-sales milestones.

The terms that decide an earnout

• The metric and how it's calculated. Revenue, net sales or a milestone such as a regulatory clearance. The contract should define the metric, the accounting used and who calculates it.
• The period and deadlines. In Fortis, each milestone had its own requirements and deadline.
• The efforts clause. This sets how hard the buyer must try. The Delaware Supreme Court described two common types in Fortis. An "inward facing" clause measures the buyer against its own practice for its own similar products. An "outward facing" clause measures the buyer against what similar industry participants would do for similar products. The court noted that an inward-facing clause is typically more buyer-friendly but can become much more seller-friendly when the buyer is an industry leader and the clause is tied to its "priority" products, as in Fortis.
• The anti-avoidance clause. The agreements in Lazard and Fortis both barred the buyer from acting to avoid the payment. The exact words matter (see Lazard below).
• Buyer control after closing. Unless the contract says otherwise, the buyer usually runs the business. In Lazard, the agreement left the buyer "free to conduct its business post-closing in any way it chose" so long as it didn't act with the intent to reduce or limit the earnout.
• Fraud and reliance clauses. In Fortis, a one-way anti-reliance clause, and how the exclusive-remedy clause applied, decided whether the seller could sue for fraud (see below).

Why earnout disputes happen, and what Delaware courts have held

1. Sellers get the protection they negotiated, not more. In Lazard, the merger agreement barred the buyer from taking "any action to divert or defer [revenue] with the intent of reducing or limiting the Earn-Out Payment." Revenue fell short, and the seller argued the buyer breached the clause by taking actions it knew would hurt the earnout. The Delaware Supreme Court disagreed: the clause "only barred the buyer from taking action specifically motivated by a desire to avoid the earn-out," and knowledge wasn't enough (the motive didn't have to be the buyer's only one, but it had to be at least part of it). The court also noted that the seller had tried to negotiate "a range of additional affirmative post-closing obligations," but the buyer rejected them.

2. The implied covenant is a narrow backstop. Under Delaware law, the implied covenant of good faith and fair dealing "inheres in every contract" (Fortis). Disappointed sellers often invoke it when an earnout misses. In Squid Soap, the seller argued the buyer had to spend at least $1 million on marketing to support the earnout, but the contract had no such spending requirement and the court rejected the claim. Reviewing that case in Fortis, the Delaware Supreme Court said "the implied covenant cannot be used to retrofit an earnout to match the disappointed seller's expectations after-the-fact." In Fortis itself, the court called the covenant "a narrow gap-filling tool of last resort" that "functions like a scalpel, not a brush," and held: "If a development could have been anticipated, even if it was unlikely to occur, the implied covenant cannot be invoked to provide protections that 'easily could have been drafted' at the bargaining table." Courts have also said that when a contract gives one party discretion, the implied covenant requires that discretion "be used reasonably and in good faith" (Squid Soap, quoted in Fortis).

3. Efforts clauses have teeth. In Fortis, J&J had to use commercially reasonable efforts consistent with its usual practice for "priority medical device products" of similar potential. After a ten-day trial, the Court of Chancery found that J&J breached that obligation and entered a judgment of more than $1 billion in contract and fraud damages, plus interest. On appeal in January 2026, the Delaware Supreme Court:

• affirmed that J&J breached its express efforts obligation on the remaining iPlatform regulatory milestones, and the damages method for them;
• reversed the trial court's use of the implied covenant to require J&J to pursue a different FDA pathway ("De Novo" review) for the first milestone. The contract expressly tied that milestone to 510(k) clearance and put on the sellers the risk that FDA "developments" could affect approval, so there was "no genuine contractual gap" to fill;
• sent the case back to recalculate the judgment without that milestone.

4. Causation still has to be proven. As the Supreme Court recounted, the Court of Chancery found that J&J breached the clause barring actions taken "with the intention of avoiding" an earnout payment, but held that Fortis didn't prove that breach was a reasonably certain cause of the missed net-sales milestones.

5. Fraud claims can survive the contract. In Fortis, the courts found that J&J, through its CEO, fraudulently induced Auris to accept a $100 million contingent payment for a lung-ablation milestone instead of a higher upfront payment, portraying the milestone as essentially certain while not disclosing a recent patient death and the FDA investigation that followed. The Supreme Court held that the merger agreement's exclusive-remedy clause didn't bar that claim "in the absence of an express anti-reliance provision running against Auris." The agreement's anti-reliance clause ran only one way: J&J disclaimed reliance, but Auris didn't.

A note on taxes

For federal income tax, a sale where at least one payment comes after the year of the sale is an "installment sale" (26 U.S.C. §453(b)). A treasury regulation calls a sale whose total price "cannot be determined by the close of the taxable year" of the sale a "contingent payment sale" and says such sales are reported on the installment method unless the taxpayer elects otherwise (26 CFR §15a.453-1(c)). Sellers can elect out (§453(d)), and some sales can't use the installment method at all, including sales of stock or securities traded on an established securities market (§453(k)(2)). Earnouts raise other tax and accounting questions too. Ask a tax adviser before signing.

How to protect yourself

If you're the seller:

• Get the metric, accounting rules and who calculates the earnout defined precisely in the agreement.
• Negotiate the protections you need in writing: an efforts standard (and what it's measured against), any required budgets, staffing or capital, limits on selling or folding the business, and what happens if the buyer is sold. After Lazard and Fortis, courts won't add them later.
• Watch the words of any anti-avoidance clause: "with the intent of" is harder to prove than a broader standard.
• Ask for information and audit rights so you can check the numbers during the earnout period.
• If a key statement by the buyer matters to you, consider making it a contract term, and pay attention to any anti-reliance clause.
• Value the earnout as uncertain. It may pay nothing.

If you're the buyer:

• Be precise about how much operating freedom you keep, and say so in the contract.
• Make sure your post-closing plans fit the efforts standard you agree to; in Fortis, measuring efforts against the buyer's own "priority" products turned out to be demanding.
• Be careful what you say during negotiations about how likely milestones are; Fortis shows that extra-contractual statements can support a fraud claim when there's no anti-reliance clause running against the seller.

If a dispute starts: check the agreement's dispute-resolution, notice and deadline provisions right away, keep the earnout statements and the business records behind them, and talk to counsel before the payment dates pass. See Mediation vs. Arbitration vs. Litigation and What Counts as Breach of Contract?.

Where the earnout fits in a deal

Deal terms such as an earnout can be outlined early, in a letter of intent, and then written in detail into the purchase or merger agreement, alongside risk clauses such as a material adverse change clause. For contested deals, where the bidder goes around the target's board, see What Is a Hostile Takeover?.

Questions to ask an M&A lawyer

• Should part of the price be an earnout at all, or would a different structure work better?
• What metric should we use, who calculates it and under what accounting rules?
• What efforts standard applies, and what is it measured against?
• What can the buyer do with the business during the earnout period, and what's off limits?
• Which state's law governs, and how do its courts treat earnouts and the implied covenant?
• How are disputes resolved, and what are the deadlines to object to an earnout statement?
• What are the tax consequences of the earnout for us?

Find a corporate or M&A lawyer

Browse Corporate Law attorneys or Business Law attorneys in the Haute Lawyer directory, or start at Find a Lawyer.

Featured: Haute Lawyer members who practice in this area include Natasha Belon (managing attorney of Lotus Law PLLC in Denver, whose business practice includes mergers and acquisitions, partner buyouts and commercial agreements) and Glenn L. Udell (partner at Brown, Udell, Pomerantz & Delrahim, Ltd. in Chicago, concentrating on real estate, corporate transactions and complex commercial litigation).

Haute Lawyer members are featured through paid membership. Membership is not an endorsement or a ranking.

Related pages

• What Is a Letter of Intent in a Business Deal?
• What Is a Hostile Takeover?
• What Is a Material Adverse Change Clause in a Business Deal?
• What Counts as Breach of Contract — and What Are Your Options?
• Mediation vs. Arbitration vs. Litigation: How to Choose
• What Is Business Succession Planning?

This page is general information, not legal or tax advice. Earnout rights depend on the specific contract and the governing state's law; consult a licensed attorney about your situation.

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