Earnouts In M&A Transactions: Bridging The Valuation Gap

In most private M&A deals, the hardest number to agree on is the purchase price. Sellers know what their business is worth based on momentum, pipeline, and potential. Buyers see risk, integration cost, and the gap between projection and reality. When those two views don’t meet, deals stall, and good companies sit on the market longer than they should.

An earnout is one of the most common tools used to break that stalemate. By making part of the purchase price contingent on how the business actually performs after closing, an earnout lets the seller capture upside if the company hits its numbers, and protects the buyer from overpaying if it doesn’t. According to the American Bar Association’s 2025 Private Target M&A Deal Points Study, earnouts appeared in roughly 18% of recent midmarket private deals, with use historically ranging from the high teens up to nearly 40% during periods of greater valuation uncertainty.

For Oklahoma business owners thinking about a sale, and for buyers eyeing Oklahoma targets, understanding how earnouts actually work, and how they fail, is one of the most valuable things you can do before sitting down at the negotiating table.

What an Earnout Is and Why It Matters

An earnout is a contract mechanism in which part of the purchase price is paid only if the acquired business hits specified targets during a defined period after closing. Accountants and finance professionals sometimes refer to it as contingent consideration. The seller receives a portion of the price up front at closing, and the rest, often a meaningful percentage of total deal value, becomes payable only when the business performs.

The economic logic is straightforward. The seller believes their business will hit a certain trajectory; the buyer is skeptical. Rather than splitting the difference at a number neither side likes, the parties agree that the seller will earn the disputed portion of the price if the company actually performs as promised. The deal happens. Both sides get the outcome they wanted, contingent on results that have yet to be proven.

The Core Promise of an Earnout

For sellers, an earnout offers a path to a higher headline price than the buyer would otherwise be willing to pay, plus a way to participate in any post-closing upside the business creates. For buyers, an earnout protects against overpaying for projections that don’t materialize, defers part of the cash outlay (helpful when financing is tight), and creates a built in incentive for the seller to support a smooth transition if they’re staying on.

The price is complexity. Earnouts add length to negotiation, ambiguity to the post-closing relationship, and a real risk of litigation if the structure isn’t airtight. Done well, they unlock deals that would otherwise die. Done poorly, they become the most painful part of an exit.

Why “Bridging the Valuation Gap” Is the Right Frame

The earnout exists to solve a specific problem: the buyer and seller disagree about what the business is worth, and neither side will move. An earnout reframes the question. Instead of arguing over what the business will do, the parties write down what the business has to do for the higher price to apply. The contract becomes the umpire, and post-closing performance becomes the answer.

How Common Are Earnouts?

Earnouts ebb and flow with the M&A cycle. They show up more often when valuation gaps are wide, financing is expensive, or the deal involves a high growth or unproven business. According to the ABA Deal Points Study noted earlier, earnouts have ranged from roughly 18% to 38% of private deals across study periods, depending on market conditions.

Industry matters even more than the cycle. In sectors where milestone based value creation is the norm, life sciences, biotech, medical devices, and certain technology businesses, earnouts can appear in well over half of deals. In stable, cashflowing businesses with long operating histories, earnouts are less common because the parties can usually agree on a number based on historical EBITDA.

When Earnouts Make Sense (and When They Don’t)

Just because an earnout can bridge a gap doesn’t mean it should. The first question every buyer and seller should ask is whether an earnout is the right tool for this specific deal.

Situations Where Earnouts Add Value

Earnouts tend to work best when the target company has a credible upside story that simply isn’t yet visible in the trailing financials. Common fact patterns include:

• Limited operating history with strong growth. A young business with a steep revenue ramp can’t be valued reliably on trailing twelve months alone. An earnout lets the buyer pay based on what actually happens next.
• New product or technology in the pipeline. If the seller’s value story depends on a product launch or regulatory approval, an earnout ties payment to the event itself.
• Temporary earnings dip. A business that took a one time hit (lost contract, supply disruption, restructuring) may be worth more than its current numbers suggest. An earnout can validate the recovery story.
• Volatile industry or economy. When commodity prices, regulatory winds, or macro conditions are swinging widely, an earnout shifts some of that uncertainty out of the closing price.
• Founder-dependent business. If the seller’s continued involvement materially affects future performance, an earnout aligns incentives. Private equity buyers in particular use earnouts this way.

Situations Where Earnouts Are a Bad Fit

Earnouts can also create more problems than they solve. Avoid (or rework) the structure when:

• The buyer plans immediate integration. If the target company will be folded into the buyer’s existing operations on day one, separating its post-closing performance becomes nearly impossible. Disputes are almost guaranteed.
• The seller is exiting completely. If the seller has no operational role and no influence after closing, every number the buyer reports becomes a potential source of conflict.
• The metrics can’t be measured cleanly. If the target’s performance can’t be isolated from the buyer’s broader business, the earnout creates ambiguity rather than clarity.
• The valuation gap is too wide. If the seller’s number and the buyer’s number differ by 50% or more, an earnout often isn’t enough to bridge the gap. The parties may simply not have a deal.

The Most Common Earnout Mistake

The biggest mistake parties make with earnouts is using them to paper over a fundamental disagreement they didn’t really resolve. If the seller secretly believes the targets are guaranteed and the buyer secretly believes they’re aspirational, an earnout doesn’t bridge the gap. It just postpones the fight. The best earnouts are negotiated by parties who can actually agree on what realistic performance metrics looks like, and are comfortable with the financial outcome at those metrics.

Structuring Earnout Targets: Financial vs. Non-Financial

Once the parties decide an earnout makes sense, the next major question is what triggers payment. Targets fall into two broad categories: financial and non-financial.

Financial Targets

Most earnouts use one or more financial metrics. The five most common are:

• Revenue. Topline sales over the earnout period.
• Net income. Bottomline profit after all expenses.
• EBITDA. Earnings before interest, taxes, depreciation, and amortization.
• Earnings per share (EPS). Used in some equity-based payment structures.
• Net equity or net assets. Less common, but used in some capital intensive deals.

Each metric advantages one side or the other:

Revenue favors sellers because it’s harder for the buyer to manipulate. The tradeoff is that revenue ignores cost discipline, so a seller running the business during the earnout could chase topline growth in ways that destroy margin. Buyers usually resist pure revenue targets for that reason.

Net income favors buyers because it captures the full economics of the business, but it’s also the most manipulable. Discretionary cost decisions, allocation of overhead, accounting elections, all flow through to the bottom line, and any of them can become disputes.

EBITDA is the most common compromise. It captures operating profitability while excluding non-operational items the parties typically don’t want either side to game. Even so, EBITDA is far from immune to manipulation. Definitions vary, and the parties almost always negotiate specific add-backs and exclusions to lock down what counts.

The EBITDA Definition Battle

The single most contested phrase in many earnout agreements is the definition of EBITDA. Should it include or exclude management fees the buyer charges the target? Acquisition-related expenses? Severance for terminated employees? Allocations of shared overhead? Stock based compensation? Each line item can swing the earnout calculation by hundreds of thousands of dollars. Both sides should walk through every reasonably foreseeable adjustment before signing, with their accountants in the room.

Non-Financial and Milestone Targets

For some businesses, financial targets don’t make sense. A pre-revenue technology company can’t promise EBITDA. A pharmaceutical target can’t predict net income before regulatory approval. In those situations, parties use non-financial milestones such as:

• FDA approval of a specific product
• Launch of a new commercial offering
• Acquisition of a minimum number of customers, contracts, or licenses
• Achievement of a specified utilization, retention, or technical benchmark
• Successful resolution of pending litigation

Milestone based earnouts are often easier to structure because the trigger is binary: either the FDA approved the drug or it didn’t, either the contract was signed or it wasn’t. There’s less room for accounting disputes. The tradeoff is that milestones can be ‘all or nothing’, which sometimes creates harsh outcomes when the target was almost (but not quite) achieved.

Combining Financial and Non-Financial Targets

Many sophisticated earnouts use both. A common structure: non-financial milestones during the early years (when the business is too immature for financial targets) and financial targets during later years (once the business has matured to where revenue and EBITDA are meaningful). Another approach uses tiered payments, where partial earnout is achieved by hitting a basic threshold and additional payments are unlocked at higher tiers.

Earnout Periods, Payments, and Caps

The length of the earnout and the structure of the payments are the next major levers.

How Long Should the Earnout Run?

Most earnouts last between one and three years. According to industry data summarized by data providers like SRS Acquiom, the median earnout period in private deals outside life sciences is roughly 24 months. Life sciences deals run longer, often 3 to 5 years or more, because milestones (regulatory approval, commercialization) take time.

The right length is a balance:

• Sellers generally prefer shorter periods to limit credit risk exposure and accelerate payment. But sellers staying on to manage may want longer periods to give themselves time to hit the targets.
• Buyers prefer shorter periods because most operational covenants protecting the seller (limits on integration, asset sales, business changes) end when the earnout ends. Buyers want their hands free.
• Both parties should remember that the longer the earnout runs, the more outside factors (economic downturns, regulatory changes, outcomes of strategic moves) can affect performance in ways neither party planned for.

Payment Structures

Payments can be structured in several ways:

• Single payment at the end, common for shorter earnouts.
• Annual payments tied to annual performance, common for multiyear earnouts. The structure should specify whether missing a target in one year can be “made up” by exceeding it the next, and whether early overperformance can offset late-year shortfalls.
• Tiered payments where partial achievement of the target produces partial payment.
• Multiple of excess, where the seller earns a multiple of every dollar of performance above the target.
• Percentage of target metric, such as a fixed percentage of EBITDA or revenue.

Caps, Floors, and Acceleration

Buyers almost always insist on a cap, the maximum amount payable under the earnout, to limit downside if the business wildly outperforms. Sellers sometimes negotiate a floor, a minimum payment owed regardless of performance, though floors are less common.

Sophisticated earnouts also include acceleration provisions, which require all remaining earnout payments to come due immediately if certain events occur. Common acceleration triggers include:

• Sale of the target company or substantial portion of its assets
• Material breach of the operational covenants by the buyer
• Termination of key employees of the target without cause
• Bankruptcy or insolvency of the buyer

From the buyer’s side, a buyout option lets the buyer pay a specified amount (often the net present value of remaining payments) to extinguish the earnout obligation early. This is useful when the buyer wants to sell the target or restructure its operations during the earnout period.

Cash vs. Equity Earnouts

Most earnouts pay in cash, but some are paid in the buyer’s stock. Equity payments raise their own issues: when is the stock valued (closing date, target measurement date, or payment date)? Will the seller get registered, freely tradeable shares or restricted stock? Does the seller get tag along rights, registration rights, or anti-dilution protection? Stock-based earnouts can also trigger securities law compliance issues and require careful structuring under federal exemptions.

Post-Closing Covenants and Operational Protections

Here is where many earnout deals fall apart, before they’re even signed. Once the deal closes, the seller’s ability to earn the contingent payment depends entirely on how the buyer runs the business. The buyer, naturally, wants maximum freedom to operate. The seller wants protections.

What Sellers Typically Ask For

Common seller protections written into the purchase agreement include:

• Operate consistent with past practice. A covenant requiring the buyer to run the target the way the seller did, or in accordance with an agreed business plan, during the earnout period.
• Best (or commercially reasonable) efforts to achieve the targets. A covenant that the buyer will actively try to hit the earnout milestones, sometimes with specified actions (minimum marketing spend, retention of key personnel, etc.).
• Maintain separate books and records. So the target’s performance can be measured cleanly.
• Maintain minimum working capital. So the business has the resources to perform.
• No disposition of the business or assets. Or at least no disposition without seller consent or earnout acceleration.
• Veto or consent rights on major decisions, like incurring debt, hiring or firing key executives, or major capital expenditures.
• Board representation. One or more seats on the target’s board during the earnout period.

What Buyers Typically Resist

Buyers push back on virtually all of these because they restrict the buyer’s ability to actually run the company they just bought. Most buyers will agree to some version of a “fair dealing” covenant, the buyer can operate the business as it sees fit, but cannot act in bad faith to deliberately defeat the earnout. In Delaware and many other jurisdictions, this is essentially the implied covenant of good faith and fair dealing the buyer is already subject to under contract law.

The 2025 ABA Deal Points Study found that only about 14% of earnout deals contained a covenant requiring the buyer to run the business consistent with past practice, and only 5% required the buyer to run the business to maximize the earnout. Buyers are winning that fight in the marketplace.

The Continued-Employment Question

If the seller is staying on as an employee of the target after closing, the parties have to address what happens to the earnout if the seller leaves. The most common structures:

• Earnout forfeited if the seller resigns or is terminated for cause. Buyer-friendly. But it can have adverse tax consequences (see Tax Treatment below).
• Earnout payable regardless of employment status. Seller-friendly. Treats the earnout as pure deferred purchase price.
• Hybrid structures with different rules depending on whether the seller leaves voluntarily, for good reason, or is terminated without cause.

The way this is structured has direct tax implications, and getting it wrong can convert what was supposed to be capital gains income into ordinary compensation income, often a 17% difference in seller’s effective tax rate.

Why Earnout Disputes Happen and How to Prevent Them

Earnouts are one of the most heavily litigated provisions in private M&A. Most disputes fall into one of three categories: calculation disputes, operational covenant disputes, and accounting principle disputes.

Calculation Disputes

The most common dispute: the seller believes the buyer manipulated the financials to reduce or eliminate the earnout payment. Did the buyer charge too many corporate-overhead expenses to the target? Did it write down inventory aggressively in the earnout period? Did it pull forward expenses to depress earnings? Did it allocate revenue to a different subsidiary?

The single best protection against calculation disputes is precision in drafting. The agreement should specify:

• Who prepares the financial statements (typically the buyer, since it controls the books).
• The exact accounting principles to be applied, usually GAAP, but with specifics about which GAAP elections, what add-backs are required, and what allocations are permitted.
• How long the seller has to review and object to the buyer’s calculation.
• The dispute resolution mechanism, usually an independent accountant whose role, scope of review, and timing are spelled out in detail.
• How the independent accountant’s fees are allocated between the parties.

Operational Covenant Disputes

The second category: the seller claims the buyer breached its post-closing covenants in ways that prevented the earnout from being achieved. Did the buyer fail to use reasonable efforts? Did it dismantle the sales team? Did it redirect the business away from the products driving the earnout?

Even when a buyer is found to have breached, sellers can face a hard time proving damages. Courts often refuse to award the full earnout amount unless the seller can show the targets would have been met but for the breach. To strengthen their position, sellers should consider negotiating liquidated damages (an agreed amount payable for specific breaches) so the seller doesn’t have to prove what the earnout “would have been.”

Accounting Principle Disputes

The third category: the parties disagree about which accounting rule applies to a particular item. Was that customer credit a refund (reduces revenue) or a marketing expense (reduces EBITDA but not revenue)? Was that legal cost an extraordinary item (excluded) or ordinary course (included)? Should that capitalized software be amortized over three years or seven?

The fix is to be specific in the agreement. Don’t just say “GAAP.” Say “GAAP, applied consistently with the target’s audited financial statements for the most recent fiscal year, with the following specific adjustments…” and then list every adjustment the parties have considered.

Earnout Litigation Is Expensive

A contested earnout claim can cost both sides hundreds of thousands of dollars in legal and accounting fees, and can take years to resolve. Even when the seller wins, the recovery often falls short of what the seller expected. The economically rational move for both sides is to spend more time on drafting precision before closing, so litigation never starts. Every hour spent tightening the earnout language is worth ten spent litigating it.

Tax Treatment: Capital Gains, Compensation, and the Installment Method

The tax consequences of an earnout are often as important as the deal economics. Three issues dominate.

1. Capital Gains vs. Ordinary Compensation Income

If the earnout is treated as deferred purchase price, the seller generally pays tax at long-term capital gains rates, currently capped at 20% federally for higher-income individuals (plus a possible 3.8% net investment income tax). If the earnout is treated as compensation for services, the seller pays tax at ordinary income rates of up to 37% federally, plus payroll taxes. The difference can be enormous.

The risk of recharacterization as compensation increases when:

• The earnout is forfeited if the seller stops working for the buyer.
• The earnout payments are tied to the seller’s individual performance rather than the company’s.
• The earnout is paid only to selling shareholders who continue as employees.
• The earnout amounts look like compensation when measured against typical industry pay for similar roles.

Sellers planning to stay on as employees should structure the earnout carefully (often with help from tax counsel) to preserve capital gains treatment. The agreement should make clear that the earnout is payable regardless of continued employment, with separate, market-rate compensation for the employment relationship.

2. Imputed Interest on Deferred Payments

If the earnout doesn’t expressly provide for interest, the IRS will impute interest under the installment sale rules. That imputed interest is taxed to the seller at ordinary income rates, even though the seller never actually receives a separate interest payment. The buyer typically gets a corresponding interest deduction. Smart drafting addresses interest explicitly.

3. The Installment Method and Its Traps

For most stock sales by individual sellers, the installment method allows the seller to defer recognition of gain until the earnout payments are actually received. The basic rules under IRS Publication 537 apply automatically unless the seller affirmatively elects out.

The traps come from the special basis recovery rules that apply to contingent payments:

• If the earnout is capped, the IRS treats the cap as the assumed selling price and allocates the seller’s basis accordingly. This can have the effect of front loading gain recognition, especially when the actual earnout payment ends up smaller than the cap.
• If the earnout has a fixed term but no cap, the seller recovers basis ratably over the term.
• If the earnout has neither a cap nor a fixed term, the seller recovers basis ratably over 15 years.

For larger deals (potential earnout payments above $5 million), Section 453A imposes an interest charge on the deferred tax liability, which can effectively eliminate the benefit of installment method deferral. Sellers in this range should run the numbers with their tax advisors before assuming installment treatment is the right path.

Tax Structuring Is Not an Afterthought

The single biggest tax opportunity in many private deals is preserving capital gains treatment for as much of the consideration as possible. For Oklahoma-based sellers paying both federal and state taxes, the spread between capital gains (federal 20% + state) and ordinary income (federal 37% + state, plus payroll taxes) can mean millions of dollars on a single transaction. Tax structuring should start the day a sale becomes a real possibility, not the week before signing.

Accounting Treatment for Buyers (ASC 805)

Buyers have their own accounting headaches with earnouts. Under FASB ASC 805 (Business Combinations), buyers must recognize the fair value of contingent consideration on the acquisition date, and then reassess fair value at each reporting period until the earnout is fully resolved.

Practically, this means:

• The buyer must estimate, at closing, what it expects to pay under the earnout, taking into account both the expected performance and the time value of money.
• If the estimate proves too low and the buyer ends up paying more, the difference is recorded as a loss on the income statement.
• If the estimate proves too high and the buyer ends up paying less, the difference is recorded as a gain.
• Either way, the buyer’s earnings can become more volatile during the earnout period.

Public buyers and buyers with sophisticated reporting requirements often resist long earnouts for this reason: the longer the contingent consideration sits on the balance sheet, the more chances it has to swing through earnings. Closely held buyers care less, but should still understand the bookkeeping.

Further, if the earnout is determined to be compensation rather than purchase price (see the tax discussion above), the buyer recognizes it as compensation expense over the service period, which generally reduces reported earnings during the earnout. This is one reason buyers and sellers usually agree to characterize earnouts as purchase price when possible.

Oklahoma-Specific Considerations

While the core mechanics of earnouts are governed by general contract and tax law, several Oklahoma-specific factors deserve attention for deals involving Oklahoma-based parties.

Choice of Law and Forum

Earnout agreements involving Oklahoma businesses often choose Delaware law because Delaware courts have developed extensive case law on earnout disputes, particularly on the implied covenant of good faith and fair dealing and the meaning of “commercially reasonable efforts.” That said, Oklahoma courts apply standard contract principles, and parties can negotiate Oklahoma law and forum where it makes sense, particularly when both parties are Oklahoma-based and want disputes resolved at home.

Oklahoma’s relatively new Business Court system, designed to handle complex commercial disputes more efficiently, has improved the appeal of Oklahoma forum selection for sophisticated transactions. For Oklahoma sellers and buyers, this is a meaningful development that should be factored into negotiations.

Oklahoma Tax Treatment

Oklahoma generally conforms to federal treatment of capital gains for individual sellers. The state’s individual income tax top rate (currently in the mid 4% range and trending lower under recent legislation) applies to gains as ordinary income at the state level, regardless of federal characterization. This means Oklahoma sellers benefit somewhat less from federal capital gains treatment than residents of zero income tax states, but the federal tax savings still dominate the picture for most deals.

Oklahoma also offers a partial capital gains deduction for the sale of certain Oklahoma-based businesses, subject to holding period and other requirements. Sellers of qualifying Oklahoma companies should evaluate whether their earnout payments fall within the deduction’s scope.

Oil & Gas Earnouts

Oklahoma’s oil and gas industry creates a unique earnout context. Asset-level acquisitions in upstream oil and gas often use earnouts tied to production milestones, drilling results, or commodity price thresholds. These deals raise their own issues around well spacing, title clearance, and the interaction between earnout payments and royalty obligations. They also often involve complex post-closing operating covenants because the buyer’s drilling and completion decisions directly drive the earnout outcomes.

Family Business and Succession Considerations

Many Oklahoma M&A deals involve family owned businesses transitioning to outside buyers, often private equity. Earnouts in these deals often combine with employment agreements for the family seller and integrate with broader succession planning objectives. Coordinating the earnout with estate planning, gift planning, and family governance considerations can preserve significant additional value.

Oklahoma’s Business-Friendly Climate

Oklahoma’s relatively low cost of operations, business-friendly tax structure, growing technology and healthcare sectors, and improving court system make it an attractive home for both buyers and sellers in private M&A. Earnouts work the same way mechanically here as anywhere else, but the surrounding economic and legal environment often makes Oklahoma deals smoother to close than equivalent deals in higher cost jurisdictions.

Earnout Alternatives: Escrows, Holdbacks, and Seller Notes

Before settling on an earnout, parties should consider whether a different structure achieves the same goal with less complexity.

Escrows and Holdbacks

An escrow places a portion of the purchase price (typically 5-15%) with a third party escrow agent for a set period after closing. The funds are released to the seller unless the buyer makes claims against them, usually for breaches of representations, warranties, or specified indemnification obligations. Escrows differ from earnouts in two important ways: the seller has already “earned” the money (it’s just held back to secure obligations), and there’s no performance contingency.

A holdback is similar but the buyer keeps the funds rather than placing them with a third party. Holdbacks are simpler but give the seller less protection that the funds will actually be paid.

Working Capital Adjustments

Most private deals include a closing date working capital adjustment. The parties agree on a target working capital amount; if the actual working capital at closing is higher or lower, the purchase price adjusts dollar for dollar (or within a band). This protects the buyer against the seller running down working capital before closing, and protects the seller against the buyer underestimating the working capital need.

Working capital adjustments don’t bridge valuation gaps the way earnouts do, but they handle a different problem: making sure the buyer gets the business in the financial condition both parties assumed.

Seller Financing

A seller note (or seller financing) is a fixed obligation of the buyer to pay the seller over time, secured (usually) by the assets or stock of the target. Unlike an earnout, the obligation isn’t contingent on performance. Seller notes are useful when the buyer needs help financing the deal but the parties don’t have a valuation gap. They can be combined with earnouts in deals where both issues are present.

‘Locked Box’ Pricing

Common in EU deals, a “locked box” mechanism fixes the purchase price as of an agreed earlier date (the “locked box date”), with covenants preventing leakage of value out of the business between that date and closing. Locked box pricing eliminates closing date adjustments but doesn’t bridge valuation gaps. It’s worth knowing about for cross-border deals.

Drafting Checklist for Oklahoma Deals

If you’re preparing for a deal that may include an earnout, the following items should appear on the checklist for both sides:

• Define the metric precisely. Don’t just say “EBITDA.” Spell out exactly what’s included, excluded, and how disputes will be resolved.
• Specify the accounting principles. “GAAP, consistently applied” is not enough. Reference specific elections, methods, and adjustments.
• Set the earnout period. Tie it to the metric chosen. One year for short-cycle businesses, longer for businesses with longer development or sales cycles.
• Cap the maximum payment. Almost universal in buyer-favorable deals.
• Address operational covenants. Even a simple “good faith and fair dealing” covenant is better than silence.
• Build in acceleration triggers. Sale of the target, breach of covenants, key employee terminations, bankruptcy.
• Spell out dispute resolution. Who prepares the calculation, who reviews it, how long the seller has to object, how the independent accountant is selected, what the accountant can review, and how fees are split.
• Address employment related earnouts carefully. If the seller is staying on, structure the earnout to preserve capital gains treatment by avoiding employment-contingent forfeiture where possible.
• Consider security for the earnout. Escrow, parent guaranty, or security interest in target assets, especially when the buyer is a thinly capitalized acquisition vehicle.
• Plan for the buyer’s setoff rights. Buyers often want to offset earnout payments against indemnification claims; sellers want to limit that right.
• Address what happens on a sale of the target. Acceleration, assumption by the new buyer, or buyout.
• Coordinate with related agreements. Employment agreements, equity awards, noncompetes, and lender covenants can all interact with the earnout.

Pre-LOI Considerations

The most leverage either party has on earnout terms is before the letter of intent (LOI) is signed. Once an LOI is in place, the price and the broad earnout structure are usually locked in, and only the details remain negotiable. Both sides should engage their advisors early enough that the LOI itself reflects a thoughtful earnout framework, not just a number on a page.

Getting an Earnout Right Starts Before the LOI

Earnouts are powerful but unforgiving. They can rescue deals that would otherwise die from valuation disagreement, but they can also turn a clean exit into years of post-closing conflict. The difference between the two outcomes is almost always in the diligence and drafting that happens before signing.

For Oklahoma sellers thinking about a sale, the right time to start thinking about an earnout is months (not weeks) before the deal becomes real. Get your books in order, get your management team aligned, get realistic about what the next two or three years actually look like, and find counsel and tax advisors who understand both the deal mechanics and your industry. The same advice applies in reverse for buyers: do enough due diligence to know what you’re really willing to pay, and make sure your earnout structure protects you against optimistic forecasts that don’t materialize.

An earnout is a contract, not a handshake. The parties who treat it that way, with the same care they’d give to any other multi-million-dollar agreement, are the ones who close deals successfully and keep the post-closing peace. Strong outcomes start with disciplined due diligence, careful structuring of the underlying acquisition structure, and tight drafting of the earnout itself.

The earnout structure is often the difference between a deal that closes and a deal that falls apart, and between a successful exit and years of post-closing pain.

Whether you’re a founder thinking about exit, a family business planning a generational transition, or a buyer evaluating an acquisition target, the structure of the earnout deserves careful attention long before signing.

Cantrell Law Firm represents Oklahoma business owners on both sides of M&A transactions. As former entrepreneurs and operators ourselves, we approach deal structuring with a practical understanding of how earnouts actually play out in the years after closing, not just how they read on paper.

• Earnout structuring and negotiation
• Purchase agreement drafting and review
• Tax structuring for capital gains preservation
• Post-closing covenant drafting
• Dispute prevention and resolution
• Coordinated estate, succession, and exit planning

Frequently Asked Questions About Earnouts

• What percentage of the purchase price is typically structured as an earnout?

  It varies widely. In middle-market deals outside life sciences, earnouts often represent 10% to 30% of total deal consideration, with a median in the 25-35% range. Life sciences and biotech deals often see earnouts representing 50% or more of total consideration, reflecting the milestone driven nature of those businesses. The right percentage depends on the size of the valuation gap and the parties’ confidence in the underlying performance projections.

• How long do earnouts typically last?

  Most earnouts run between 1-3 years, with midsize deals commonly set at 2 years. Life sciences earnouts often run 3-5 years or longer because their milestones (regulatory approvals, commercial launches) take time. The length should match the metric: short timelines for short-cycle businesses, longer for businesses where the value story takes time to play out.

• Can a buyer prevent the seller from earning the earnout by changing how the business is run?

  Sometimes, yes, which is why post-closing covenants and dispute-resolution mechanisms matter so much. Most jurisdictions, including Delaware (often chosen as the governing law) and Oklahoma, recognize an implied covenant of good faith and fair dealing that prevents the buyer from acting in bad faith to deliberately defeat the earnout. But proving bad faith is difficult, and the buyer generally has wide latitude to operate the business as it sees fit unless the agreement says otherwise. Sellers should negotiate for specific operational covenants where the risk is high.

• What happens if the buyer sells the company during the earnout period?

  Whatever the agreement says will happen. Most earnout agreements address this directly with one of three approaches: acceleration (the full earnout becomes immediately due), assumption (the new buyer steps into the shoes of the original buyer), or buyout (the original buyer pays an agreed lump sum to extinguish the obligation). Sellers usually prefer acceleration; buyers usually prefer assumption or buyout. If the agreement is silent, disputes are almost certain.

• Are earnout payments taxed as capital gains or ordinary income?

  Generally, earnout payments treated as deferred purchase price are taxed as capital gains; payments treated as compensation for post-closing services are taxed as ordinary income. The characterization depends on facts and circumstances, including whether the earnout is forfeited if the seller leaves employment, how the amount compares to typical compensation for the seller’s role, and how the agreement is drafted. Sellers should structure the earnout with tax counsel to preserve capital gains treatment where possible.

• What’s the difference between an earnout and a holdback or escrow?

  An earnout makes part of the purchase price contingent on the target’s future performance. A holdback or escrow holds back part of the price the seller has already earned, to secure the seller’s indemnification obligations for breaches of representations and warranties. Earnouts address valuation uncertainty; escrows address risk allocation. Many deals include both.

• What financial metric is best for an earnout?

  EBITDA is the most common compromise because it captures operating profitability while excluding nonoperational items both sides typically don’t want gamed. Sellers often prefer revenue (less manipulable but ignores costs); buyers often prefer net income (most accurate but most manipulable). The right metric depends on the business, the industry, and what the parties are actually trying to measure. Whatever metric the parties choose, the definition should be specific enough to avoid disputes.

• Should an earnout be paid in cash or stock?

  Most earnouts are paid in cash. Stock-based earnouts can work but introduce additional complexity: when is the stock valued, will it be registered, what rights does the seller have? For Oklahoma sellers, stock based earnouts in private buyer companies also create liquidity issues that should be addressed in the agreement (registration rights, redemption obligations, or buyback options).

• Can an Oklahoma business owner negotiate an earnout without a national law firm?

  Yes, and many of the most sophisticated middle market deals are handled by Oklahoma counsel who combine deep technical expertise with practical operational understanding. The key is finding counsel with substantive M&A experience and tax structuring sophistication, not just transaction volume. National firms can be appropriate for very large deals or specialized industries, but they’re not necessary for most middle market Oklahoma transactions.

• How do earnouts interact with non-compete and non-solicitation agreements?

  They often interact significantly. If the seller is staying on as an employee, the non-compete typically runs from the end of employment, not from closing, which can extend the seller’s restrictions for years. The earnout should align with these restrictions: a seller subject to a long non-compete needs the earnout to compensate for that constraint. Oklahoma’s strict approach to non-competes adds another wrinkle, since some buyer-favored restrictions may be unenforceable here.