Earnout provisions are sometimes used in business sales when part of the purchase price depends on the company’s performance after the transaction closes. Disputes can arise when buyers and sellers disagree about whether performance targets were reached or how an earnout should be calculated.
Under California law, courts may examine the language of the parties’ agreement, the financial measurements used to determine payment, and the conduct of the parties after the sale. These disputes can involve revenue calculations, accounting methods, operational decisions, and other factors affecting the earnout.
How Courts Interpret Earnout Provisions
Courts may begin by examining the language establishing the earnout and the conditions governing payment. The agreement may identify financial targets, measurement periods, calculation methods, and other terms affecting whether additional compensation becomes due.
The wording of these provisions can become particularly important when the parties disagree about how performance should be measured. Courts may examine the agreement as a whole when determining how the earnout provisions apply to the dispute.
How Performance Targets Become Relevant
Earnouts frequently depend on whether a business reaches specified financial or operational targets after a sale. These targets may involve revenue, earnings, sales, customer growth, or other measurements selected by the parties.
Courts may examine financial records and other business information to determine how the relevant targets were calculated. The specific measurements established by the agreement can shape the analysis of whether an earnout payment was triggered.
How Courts Examine Accounting Methods
Accounting practices can become a significant issue when an earnout depends on financial performance. Buyers and sellers may disagree about how revenue, expenses, or other financial information should be recorded when calculating the payment.
Courts may examine the accounting provisions contained in the agreement along with the methods actually used after the transaction. Financial statements, internal records, and calculations can help explain why the parties reached different earnout amounts.
How Post-Sale Business Decisions Can Matter
The buyer generally controls the business after an acquisition, which can make post-sale decisions relevant to an earnout dispute. Changes involving operations, staffing, pricing, expenses, or business strategy may affect the financial results used to calculate an earnout.
A dispute may involve allegations that certain decisions improperly reduced or changed the amount that became payable. Courts may examine those decisions in light of the obligations established by the parties’ agreement.
How Courts Evaluate the Amount Owed
When an earnout has been triggered, the parties may still disagree about the amount that should be paid. Courts may review the applicable formula and the financial information used to calculate the disputed payment.
Records concerning revenue, expenses, adjustments, and prior payments can become relevant to this analysis. The calculation ultimately depends on the terms the parties established for determining the earnout.
Why Earnout Payment Disputes Matter
Earnouts can allow parties to connect part of a business purchase price to future performance, but they can also create disagreements long after a transaction has closed. Clearly defined financial measurements and calculation procedures can become especially important when expectations differ.
When a dispute develops, courts may examine the agreement alongside the company’s subsequent financial performance and the parties’ conduct. This analysis can determine whether an additional payment is owed and how that payment should be calculated.
