How to Structure and Negotiate Earnouts and Holdbacks in Business Acquisitions

When buyers and sellers can't agree on a business's value at closing, deal structures like earnouts, holdbacks, and seller financing can help bridge the gap. Each mechanism carries distinct legal and practical implications. Knowing how to negotiate and document these provisions protects your investment and reduces the likelihood of post-closing disputes.

Earnouts: Contingent Consideration Based on Future Performance

An earnout is a contractual provision tying a portion of the purchase price to the acquired business meeting specific post-closing performance targets, typically measured by revenue, EBITDA, or defined operational milestones. Earnouts are especially common when the parties have differing expectations about future value, or when seller expertise (and continued involvement) is critical to post-transaction success.

Key Provisions to Negotiate

Clear Performance Metrics: Define objective, auditable benchmarks. For example, revenue-based targets are generally easier to measure and less susceptible to manipulation than net income or profit margins.

Duration: Earnout periods typically range from one to five years, though the shorter end of that range is more common for smaller businesses.

Operational Protections and Acceleration Clauses: Sellers can negotiate covenants that protect their ability to earn the earn-out, like covenants requiring buyers to operate the business in good faith, maintain adequate staffing, and avoiding actions that could suppress earnout results (e.g., diverting revenue streams or loading expenses). If the buyer sells or materially changes the business, acceleration provisions can trigger immediate payment of remaining earnouts.

Holdbacks: Protecting Against Post-Closing Risk

A holdback is a portion of the purchase price retained by the buyer or deposited into a third-party escrow account. The seller earns the holdback when specific conditions are met or a set period of time elapses without certain events occurring. Holdbacks can serve as insurance against undisclosed liabilities, breaches of representations and warranties, or unfulfilled post-closing obligations.

Structuring Effective Holdbacks

Specify Release Conditions: Clearly define what triggers release—such as the expiration of a survival period, resolution of pending claims, or the seller's fulfillment of transition obligations.

Release Schedule: Staggered releases (e.g., 50% after six months, the remainder after 12–24 months) can better align risks with the period in which undisclosed liabilities are most likely to surface.

Cap and Basket: Set a maximum holdback amount (cap) and a minimum claim threshold (basket) to prevent minor issues from consuming funds or triggering prolonged disputes.

Third-Party Escrow: Sellers often prefer funds held by a neutral escrow agent rather than retained by the buyer, reducing the risk of non-payment if the buyer encounters financial difficulties.

Conclusion: Protect Your Interests with Careful Structuring

Earnouts and holdbacks are powerful tools for getting business transactions across the finish line. Experienced outside counsel can help ensure that these provisions align with your interests and minimize the risk of costly post-closing disputes.

Questions about structuring or negotiating your next business transaction? Contact Elkhoury Law for deal-specific guidance.