Earn-Outs in M&A: Why the Deferred Part of the Price Often Ends in Court
Earn-outs close valuation gaps but often open disputes. The J&J (Auris Health) and Alexion (Syntimmune) rulings show how courts read earn-out terms, and what buyers and sellers must write into the agreement before signing.
An earn-out is a part of the purchase price that the buyer pays only if the business meets agreed targets after closing. The targets can be revenue, EBITDA or, in life sciences, regulatory milestones. Buyers use earn-outs when they and the seller do not agree on the value of the business. In 2019, Johnson & Johnson bought Auris Health, a maker of surgical robots, for USD 3.4 billion. The deal also had up to USD 2.35 billion in milestone payments. In September 2024, the Delaware Court of Chancery found that J&J breached its earn-out obligations. The court awarded the sellers more than USD 1 billion plus interest. It also found fraud, because J&J did not tell the sellers about an FDA investigation before closing (Legal Dive, 2024). One day later, the same court found Alexion liable in a different earn-out case. Alexion had bought Syntimmune with up to USD 800 million in milestone payments. The court held that Alexion stopped development of the product for merger synergy reasons. This did not meet its duty of "commercially reasonable efforts" (Mayer Brown, 2024).
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How Common Earn-Outs Are, and What They Pay
According to the 2026 SRS Acquiom study, 24% of non-life sciences private-target deals in 2025 had an earn-out. This is up from 17% in 2014 to 2022. In biotech and pharma, the figure was 78%. Across all earn-out deals, sellers received about 21 cents of each potential dollar. In deals with some success, they received about 50 cents. What this means: For a seller, an earn-out is not the same as price. For a buyer, a low payout is not a gain if the result is a court case that costs more than the earn-out.
Why Earn-Outs Lead to Disputes
• Control after closing. The buyer operates the business. Its decisions change the result that the seller depends on. • Unclear efforts clauses. "Commercially reasonable efforts" has no fixed meaning. Courts read the contract text and examine the conduct of the buyer. • Metric definitions. Revenue and EBITDA change with accounting policies and cost allocations. If the agreement does not lock the definitions, each side calculates a different number. • Integration. When the buyer merges teams, products or systems, it becomes difficult to measure the target as a separate business.
What to Check Before You Sign
• Define each metric line by line. Attach a sample calculation that uses the actual historical numbers of the target. • Lock the accounting policies for the earn-out at the closing date. • Write the efforts duties in specific terms: budget, headcount, timelines, and the decisions the buyer can make alone. • State which group costs the buyer can allocate to the target. • Test the earn-out targets against a Quality of Earnings baseline, not against the forecast of management. • Set a clear dispute process. Use an independent accountant for calculations and the courts for conduct claims. These are the same controls that protect a working capital peg. In both cases, the buyer has the most negotiation power before signing, not after closing.
Where MARC Comes In
• Build the earn-out baseline from QoE-adjusted earnings. • Prepare metric definitions and sample calculations with deal counsel. • Model probability-weighted payouts to support the price negotiation. • Prepare and review earn-out calculations after closing. Speak with MARC's advisory team before you agree to your next earn-out.
FAQs
What is an earn-out? It is a part of the purchase price that the buyer pays after closing, only if the business meets agreed targets. The targets are usually revenue, EBITDA or a regulatory milestone. How much of an earn-out do sellers usually receive? Across all earn-out deals, sellers received about 21 cents of each potential dollar, according to SRS Acquiom. In deals with some success, they received about 50 cents. How can buyers decrease the risk of an earn-out dispute? Use precise metric definitions, a sample calculation, locked accounting policies and specific efforts duties. Test the targets against a QoE baseline before signing.
Key Takeaway
An earn-out moves a disagreement about value to a later date. It does not remove the disagreement. The best protection for both sides is a precise agreement and a realistic earnings baseline before signing.
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Speak with MARC's advisory team before you agree to your next earn-out.
