Principal Attorney
You’ve negotiated a deal, but you and the buyer can’t agree on what your business is worth. Earn-outs offer a solution: part of the purchase price is paid after closing, based on how the company performs. When structured correctly, earn-outs align incentives, reduce upfront risk, and bridge valuation gaps. But poorly drafted provisions can lead to costly disputes. In this guide, our Dallas mergers & acquisitions attorney explains how to structure enforceable earn-outs under Texas law and avoid the pitfalls that derail deals.
Understanding Earn-Outs in Texas M&A Transactions
An earn-out is a contractual provision in which part of the purchase price is paid after closing, contingent on the acquired company meeting specific performance targets. Common metrics include EBITDA, gross revenue, or customer retention, typically measured over one to three years.
Earn-outs are especially useful when buyers and sellers disagree on valuation. A seller confident in future growth may accept a lower upfront payment in exchange for performance-based payouts that could exceed the original asking price. In Dallas, where M&A activity is strong in sectors like energy and technology, earn-outs are frequently used to manage uncertainty and align long-term interests.
Key Elements of a Well-Structured Earn-Out
To avoid disputes and ensure enforceability, earn-outs in Texas M&A deals should include the following core elements.
Performance Metrics
The foundation of any earn-out is the performance metric. Choose objective, measurable criteria that can be verified through standard accounting practices. Use GAAP-compliant EBITDA, gross revenue, or other auditable financial indicators. Tie calculations to financial statements reviewed or audited by independent accountants. Clear metrics reduce ambiguity and help both parties understand exactly how payments will be calculated.
Payment Terms
Define how and when the earn-out will be paid. This includes the duration of the earn-out period and any limits on the total payout. Set a defined schedule, such as annual installments over two or three years. Include caps to limit the buyer’s exposure and floors to protect the seller’s minimum expectations. These terms help manage financial risk and provide predictability for both sides.
Dispute Resolution
Earn-outs are a common source of post-closing disputes. To reduce the risk of litigation, include mechanisms for resolving disagreements. Use arbitration clauses to avoid lengthy court battles. Designate a neutral, independent accountant to make final calculations if disputes arise. Avoid vague language that could lead to conflicting interpretations or legal challenges.
Protections for Both Parties
A well-balanced earn-out protects the interests of both buyer and seller. Buyers should retain operational control and flexibility to integrate the acquired business. Sellers may seek covenants that prevent the buyer from taking actions that could artificially reduce performance metrics. These protections help ensure the earn-out reflects genuine business performance, not post-closing manipulation.
Why Express Covenants Matter Under Texas Law
Texas courts do not recognize a general implied duty of good faith and fair dealing in ordinary commercial contracts, including M&A transactions. This means sellers cannot rely on courts to impose fairness obligations that weren’t explicitly negotiated.
As a result, sellers must negotiate express covenants specifying how the buyer will operate the business post-closing. Examples include covenants to operate “consistent with past practices,” restrictions on major cost changes or personnel decisions, and provisions requiring “commercially reasonable efforts” to achieve performance metrics. These covenants should include objective, measurable standards to be enforceable.
Actionable Tips for Dallas Business Owners and Investors
To structure a successful earn-out in a Dallas M&A transaction, keep these best practices in mind:
- Engage an experienced Texas M&A lawyer early in the process to draft enforceable, metric-driven provisions
- Use independent accountants to verify post-closing performance and minimize disputes
- Include arbitration clauses and other dispute resolution mechanisms tailored to Texas law
- Negotiate express covenants that govern post-closing operations, since Texas courts won’t imply them
- Consider industry-specific risks, especially in volatile sectors like energy or technology
- Document all financial models and assumptions used in calculating earn-out payments
These steps can help protect your interests and ensure a smoother post-closing experience.
How a Dallas M&A Attorney Can Help You Structure a Stronger Deal
Earn-outs can bridge valuation gaps and align long-term goals, but only if they’re structured with clarity and foresight. At Sul Lee PLLC, we help Dallas business owners, investors, and executives navigate complex M&A transactions with tailored legal strategies. Contact our team today to discuss how to structure your next deal with confidence.