Earnout Governance Is the Problem You Signed Up For
Closing ends the negotiation. It doesn't end the earnout.
Once the agreement is signed, the buyer runs the business, the seller waits for a number, and a clause written months earlier is the only thing connecting them. Most of the attention goes to targets, definitions, and accounting terms. ACG Strategic Insights covered how to structure earnouts in February. Structure is a promise. Whether that promise gets kept depends on how the earned metric is tracked, measured, and protected after the deal closes.
The data shows how often that part goes wrong. SRS Acquiom, a U.S. shareholder representative firm, reports in M&A Earnout Provisions – What You Need to Know that earnouts in the private-target deals it tracks pay about 21 cents on the dollar and are contested at least 28% of the time. Of the deals that paid anything, 17% needed a renegotiation to avoid litigation. That comes from one firm's book of business, so treat it as a signal and not a universal rate. It's still a signal worth taking seriously.
Why Earnout Governance Slips After Closing
Control passes to the buyer at closing, and the seller's view into the business often shrinks. SRS Acquiom notes in M&A Earnout Provisions – What You Need to Know that unless the purchase agreement provides for it, sellers will likely have no visibility into post-closing operations or financial information, and a buyer generally owes no information the agreement doesn't require. A seller can't monitor what it can't see. The same source puts the median earnout period at 24 months, which is a long time to go without a clear line of sight.
The buyer's side has its own gap. The ICAEW Corporate Finance Faculty, with Grant Thornton UK LLP as authors, observes in its Best-Practice Guideline 70, Earn-Out Agreements, that many purchasers fail to keep separate records for the acquired business during the earn-out period. Finance teams then work backward near the end, building earn-out accounts from statutory or management numbers after operational changes were made without regard to their effect on the earnout. The same guideline says finance staff need to understand the earnout accounting principles, especially when they weren't involved in the deal.
That's the earnout governance gap in miniature. Legal holds the agreement, finance calculates the metric, operations runs the business, and the teams combining the two companies reshape it. Each does its job, and nobody owns the whole.
Where Earnout Disputes Really Begin
The ICAEW guideline, Earn-Out Agreements, lists the most frequent causes of earnout disputes. They include ambiguous drafting, different readings of how the performance measures should be calculated, changes in the business during the earn-out period, and accusations that accounting was manipulated or that the business was run in breach of the agreement's protections. Only the first is a drafting problem. The other three show up after closing, in ordinary management decisions.
The same Earn-Out Agreements gets specific. Disagreements arise when the target moves onto the purchaser's reporting policies, when its IT, HR, or accounting functions are replaced by purchaser services with recharged costs, when the business is folded into another part of the purchaser's group, and when nobody has agreed how to count savings from combining operations. Sellers may allege the buyer deferred revenue or overspent on discretionary items. Buyers may suspect the previous owners underspent on marketing or pulled revenue forward before the sale. The guideline also warns that a seller who stays in a key role and chases a revenue threshold may favor low-margin contracts, and that profit targets can be met artificially through cost deferrals. The risk runs both ways. Results that land near a threshold draw the closest scrutiny, because a small gain in performance can move the payment by a large amount.
Finance teams can produce defensible numbers that still miss the contract's basis. The question isn't whether the books are right. It's whether they're right for the purpose the agreement sets. Russell L. Ackoff made a broader point about objectives in Transforming the Systems Movement, published in The Systems Thinker, but it fits here. "The righter we do the wrong thing, the wronger we become." Precision aimed at the wrong measure only compounds the error.
The Buyer's Own Records Become the Evidence
A recent ruling shows how this plays out at scale. In Johnson & Johnson v. Fortis Advisors LLC, decided January 12, 2026, the Delaware Supreme Court reviewed a post-closing earnout dispute under Delaware law in the United States. Johnson & Johnson (J&J) had acquired Auris Health in 2019 with up to $2.35 billion in earnouts tied to 10 milestones, and none was paid. The Delaware Court of Chancery awarded the former stockholders more than $1 billion, and the Supreme Court affirmed most of it.
What carried the sellers' case was the buyer's own paper trail. According to the court's account in Johnson & Johnson v. Fortis Advisors LLC, J&J wrote the milestones down to zero in April 2020 and booked a gain of about $983.6 million by releasing the related reserves. Two months later it revised incentives so Auris staff no longer earned rewards for the contractual milestones. Its chief financial officer told the CEO that a combined-platform strategy looked better once the missed milestones were counted. The courts treated that kind of reasoning as the earnout-avoiding decision making the contract prohibited, and they measured J&J's effort against how it treated its own priority device.
This is an extreme case. It involved a $2.35 billion earnout, a tailored efforts clause, and a buyer with its own comparable product to measure against. Smaller deals will turn on different facts. The mechanism still travels. Every pricing change, cost allocation, reorganization, incentive plan, and accounting entry that touches the metric leaves a record, and in a dispute that record becomes the evidence. Who reads those decisions against the earnout clause before they're made?
The Law Will Not Fill Your Gaps
Delaware courts have said this more than once. In Lazard Technology Partners, LLC v. QinetiQ North America Operations LLC, decided in 2015, the Delaware Supreme Court affirmed judgment for a buyer after sellers claimed it had undermined their earnout. The agreement barred only actions taken with the intent to reduce or limit the payment, and the sellers could not prove that intent. The record showed they had asked for affirmative post-closing obligations, including a promise not to divert business opportunities away from the company, and lost that point at the bargaining table.
The J&J ruling cuts the other way on its facts and holds to the same principle. In Johnson & Johnson v. Fortis Advisors LLC, Justice LeGrow said the protection the sellers lacked belonged "ex ante at the bargaining table, rather than ex post in the courtroom." The court reversed the first-milestone ruling because the agreement named one regulatory pathway and left no gap for the implied covenant of good faith to fill. The wording of the clause decided each case. An intent standard protected the buyer in Lazard. A tailored efforts standard, measured against the buyer's own priority product, cost the buyer in J&J.
English law reaches a similar place by a different route. Lawyers at Winston & Strawn in London write in Earn-outs: A bridge to troubled water? for Private Equity International that English law imposes no general duty of good faith in commercial contracts, so unless the share purchase agreement contains express covenants, a buyer has no obligation to increase the seller's return. Earn-outs: A bridge to troubled water? also describes an English High Court dispute involving DXC Group, where earnout calculations were emailed in disregard of the contract's notice provisions. The court ordered the parties to carry out the dispute resolution procedure in their agreement.
The details change by jurisdiction. The practical point holds. In each case the court held the parties to the contract's words and to the procedures they agreed to follow.
A Monitoring Routine That Holds Up
Start with the accounting. Earn-Out Agreements advises setting an order of priority for accounting policies in the agreement, often starting with specific policies written into it, then the policies in a defined set of historical accounts, then the applicable GAAP or IFRS. It also suggests freezing the version of GAAP or IFRS so later changes to standards don't skew the numbers, and it says purchasers can consider a separate set of books when earn-out accounting departs from statutory or management reporting. That matters most in cross-border deals, where the parties may report under different frameworks.
The ICAEW guideline, Earn-Out Agreements, is direct about communication. "Ongoing communication between the parties during the earn-out period is essential." Sharing pro forma earn-out accounts on an agreed schedule surfaces disagreements while both sides still need each other, before positions harden all at once.
Information rights come next. SRS Acquiom describes in M&A Earnout Provisions – What You Need to Know well-drafted rights that give named seller representatives periodic reports with supporting detail, the ability to request meetings and speak with knowledgeable buyer staff, and a process to review, correct, or dispute what's reported. Buyers gain too, because regular updates manage a seller's expectations before the final number arrives.
I'd add five habits that cost little:
Name one accountable owner on each side. The buyer's owner doesn't need power to override business decisions, only the job of making sure decisions with earnout consequences get reviewed against the clause and the records are kept. On larger deals, a small group from finance, legal, operations, and the teams combining the businesses can support that owner, with a clear path for escalating issues.
Map every earnout metric to the accounting records, definitions, permitted adjustments, and people that produce it, so finance can show how the contractual figure comes from the books.
Keep a decision log. Any pricing, cost allocation, staffing, or reorganization decision that touches the metric gets checked against the clause, and the reasoning is written down at the time. The J&J case turned on internal records made in the ordinary course, and yours will be read the same way.
Put the earnout on the monthly close calendar, and hold a regular review where buyer leadership and the seller's former management look at progress together.
Agree on the dispute path early, including where notices go, how they're delivered, and who serves as expert if talks stall.
The last habit has a cost argument behind it. The ICAEW guideline, Earn-Out Agreements, notes that expert determination by an independent accountant is usually quicker and cheaper than court or arbitration, that the accountant's role is usually limited to the items in the dispute notice, and that courts are unlikely to be sympathetic to a party that issues a defective notice. It also warns that such disputes can break the relationship between purchaser and seller, who may still be working together.
When an Earnout Reaches the Board
Not every earnout needs the board, but directors should look closer when the contingent amount is material, when the metric is sensitive to management discretion, or when a dispute threatens the deal's economics. One pattern deserves a question. When management reports large savings from combining the businesses while the acquired company is on track to miss its earnout, the board should ask whether the business is underperforming, whether the measurement basis has changed, or whether the original assumptions no longer hold. That pattern isn't proof of misconduct. It's a reason to ask. Directors don't need to calculate the earnout. They need confidence that management has a defensible process for doing it.
Three questions show where you stand. Who owns the integrity of the earnout calculation? Who reviews the operating decisions that could change it? And how quickly would leadership learn that buyer and seller no longer agree on the numbers? If the honest answer is nobody and nothing, earnout governance hasn't started.
This article offers general information about earnouts and is not legal, tax, accounting, or investment advice. Earnout rights, remedies, and duties differ by jurisdiction and by contract. Consult qualified legal, tax, and accounting advisers before acting on any matter described here.
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