Deal Autopsy: The Earn-Out That Became a Four-Year Argument — and What It Teaches Every Buyer
All details in this account have been anonymised. The sector, the individuals, and the specific figures have been changed to prevent identification. The structural problem, the escalation, and the lessons are drawn directly from a real transaction.
Earn-outs are supposed to bridge a valuation gap. A seller believes the business is worth more than a buyer is prepared to pay today. So part of the consideration is made contingent on future performance — if the business hits the targets, the seller gets the additional payment. Both parties get what they need. The deal completes. Everyone moves on.
That is the theory. In practice, earn-outs are among the most consistently contentious elements of any acquisition — and the one I am going to describe here is one of the cleaner examples of how an apparently sensible earn-out structure can unravel completely when the underlying assumptions are not properly tested and the documentation is not tight enough.
By the time it was finally resolved, four years after completion, both parties had spent more on legal fees than the disputed earn-out payment was worth. The seller was furious. The buyer was exhausted. And the business — caught in the middle of a running dispute between its new owner and the previous one — had suffered in ways that showed up in the financial results.
The Deal
The business was a specialist professional services firm — a sector where recurring client relationships are the primary asset and where much of that relationship typically sits with senior individuals. Revenue of just under £3.5m, EBITDA of £480k, and a founding director who had built the business over two decades and wanted to exit within two years of completing a sale.
The buyer was an experienced operator with relevant sector knowledge who saw a genuine opportunity to grow the business by introducing a broader service offering and expanding geographically. The business had a strong reputation, a loyal client base, and a management team that was largely in place — but the founding director was still the most recognisable face of the firm and retained a number of the most significant client relationships personally.
The headline price was £2.4m — five times normalised EBITDA. Of that, £1.6m was payable on completion and £800k was structured as an earn-out payable over two years, linked to EBITDA performance in years one and two post-completion.
On the face of it, the structure made sense. The seller remained in the business for the earn-out period, the buyer reduced their upfront risk, and the seller had a financial incentive to ensure a smooth transition. Both sides' advisers reviewed it. Legal documentation was produced. The deal completed.
The First Year
Twelve months after completion, the year one earn-out calculation was due. The seller's position was that EBITDA for year one had hit the target. The buyer's position was that it had not — and that the calculation method the seller was applying was inconsistent with the definition in the share purchase agreement.
The specific dispute centred on two things.
The first was the treatment of central costs recharged by the buyer's group to the acquired business. The buyer had, post-completion, introduced a management charge — a monthly recharge from the parent company covering shared services: finance, HR, IT, legal, compliance. This was a legitimate and entirely standard practice in a group structure. The charge was approximately £7,500 per month — £90k per year. The seller argued that this charge had not existed pre-completion and should be excluded from the EBITDA calculation for earn-out purposes. The buyer argued that the SPA defined EBITDA in accordance with the accounting policies of the group, which included the management charge.
The second issue was the treatment of a one-off cost the buyer had incurred in year one to relocate the business to new premises. The relocation had been the buyer's decision — the seller had not been consulted — and it had cost approximately £55k in one-off fit-out and moving costs. The buyer included this in the EBITDA calculation as a legitimate operational cost. The seller argued it was a one-off capital decision made unilaterally by the new owner and should be excluded.
Together, these two adjustments represented approximately £145k in EBITDA. The earn-out payment in year one was linked to EBITDA exceeding £490k. Reported EBITDA, before the disputed items, was £512k. After the disputed items, it was £367k. The difference between the two positions was not academic — it was the difference between the seller receiving £400k in year one earn-out payments and receiving nothing.
How It Escalated
The parties could not agree. Both positions had some merit. The SPA language was ambiguous on both points — not because the lawyers had been careless, but because nobody had explicitly contemplated these specific scenarios when the documentation was drafted. The management charge had not been discussed during negotiations because the buyer had not yet decided to implement one. The relocation had not been discussed because it had not been planned at the time of completion.
Formal dispute resolution proceedings were initiated. The SPA contained an expert determination clause — in theory, an efficient mechanism for resolving accounting disputes without full litigation. An independent accountant was appointed as expert. The process took seven months. The expert found in favour of the seller on the management charge point and in favour of the buyer on the relocation cost point. The net result was an earn-out payment materially lower than the seller had expected but higher than the buyer had calculated.
The seller accepted the determination on the management charge and the relocation cost. But the process had produced something else the expert determination clause had not resolved: a deeply damaged relationship between the buyer and the seller who was still, remember, working in the business during this period.
Year two of the earn-out was worse. With the relationship now adversarial, every management decision became contested. The seller argued that strategic decisions made by the buyer — changing the pricing structure, introducing new services, restructuring the management team — were deliberately designed to suppress year two EBITDA and reduce or eliminate the earn-out payment. The buyer argued they were legitimate business decisions that any new owner would make. Both positions were partially true.
Year two earn-out proceedings produced a second expert determination. A second set of legal fees. A second period of uncertainty for the management team and the clients who could sense that something was wrong at the top of the business. By the end of year two, two senior client relationship managers had left — partly, in the view of those who were there, because of the visible instability at ownership level.
The final resolution — a negotiated settlement that combined the year two determination with a lump sum payment to end all outstanding claims — came eighteen months after the formal earn-out period had expired. Four years after completion.
What Went Wrong: in Sequence
This deal did not fail because anyone was dishonest. It failed because a series of structural problems, each manageable in isolation, compounded into something that became very difficult to resolve.
The earn-out metric was not precisely defined
EBITDA as a metric is not self-defining. In a standalone business, pre-acquisition, it is reasonably clear — earnings before interest, tax, depreciation, and amortisation, with whatever normalisation adjustments are agreed. In a business that becomes part of a group post-acquisition, the picture changes immediately. Management charges, shared service allocations, group insurance policies, group procurement arrangements — all of these affect what the EBITDA of the subsidiary looks like. An earn-out definition that does not explicitly address how the business will be treated within the acquiring group is an earn-out definition waiting to be disputed.
The fix: define EBITDA for earn-out purposes as a standalone figure, calculated as if the business were not part of any group. Exclude any charges, allocations, or costs that did not exist pre-completion unless explicitly agreed. This should be negotiated and documented before completion, not left to interpretation afterwards.
The buyer's operational discretion was not constrained
An earn-out gives the seller a financial interest in the future performance of a business they no longer own. That creates an obvious tension: the buyer now has full operational control, and the decisions they make will affect the earn-out metric. Without contractual constraints on the buyer's behaviour during the earn-out period, the seller is exposed to decisions that may be entirely legitimate from the buyer's perspective but which materially damage the seller's earn-out outcome.
Standard earn-out protection provisions for sellers include: a requirement that the buyer operates the business in the ordinary course during the earn-out period, restrictions on significant capital expenditure decisions that were not planned pre-completion, restrictions on changes to the management structure or key personnel without seller consent, and a prohibition on transactions between the acquired business and the wider group that are not on arm's length terms. None of these were included in this SPA.
The seller was still in the business
Earn-outs work best when the seller is genuinely incentivised to make the business succeed under new ownership — and when the relationship between buyer and seller is strong enough to survive the inevitable friction of a transition. In this case, the relationship broke down in year one and the seller spent year two oscillating between working to hit targets and feeling that the game was rigged against them.
The most honest assessment is that an earn-out with a two-year seller involvement period was probably the wrong structure for this deal. The seller had built the business over twenty years and had strong views about how it should be run. The buyer had a different vision. Those two things are not necessarily incompatible — but they require a much more carefully managed governance arrangement than this deal had.
An earn-out that keeps the seller in the business for two years should be accompanied by a clear governance framework that defines who makes which decisions, how disagreements are escalated, and what the seller's role and authority actually is during the earn-out period. Without that framework, the earn-out period becomes a power struggle rather than a collaborative transition.
The dispute resolution mechanism was too slow
Expert determination is generally faster than litigation — but seven months for a year one calculation dispute is still seven months in which the relationship is frozen, the management team is unsettled, and nothing can be resolved. The dispute resolution mechanism in an earn-out SPA should be faster than this — ideally with a nominated expert agreed at the time of the deal (not appointed after the dispute arises), a defined timetable for the process, and interim payment arrangements that mean neither party is carrying the full financial uncertainty while the determination is pending.
The Earn-Out Checklist: What Should Be in the Documentation
Based on this deal and others like it, here is the minimum documentation standard for any earn-out structure:
EBITDA definition specified as a standalone figure, explicitly excluding all group allocations, charges, and costs unless specifically agreed otherwise
A list of the specific adjustments that will and will not be made — not by reference to accounting policies that may change, but as a specific agreed schedule
Operational covenants on the buyer — ordinary course of business obligation, material capex restrictions, key personnel protections, related-party transaction constraints
A governance framework for the earn-out period — seller's role, decision rights, escalation process
A named independent expert agreed at completion, available to be appointed immediately if a dispute arises
A defined timetable for the earn-out calculation and dispute resolution process — with teeth, not just aspirational timelines
Interim payment arrangements if the calculation is disputed — so neither party carries the full financial uncertainty while the process runs
A cap on legal costs that can be recovered in the dispute process — perverse as it sounds, removing the ability to recover legal costs can reduce the incentive to litigate
When to Use an Earn-Out and When Not To
The lesson from this deal is not that earn-outs are bad structures. They are useful tools in the right circumstances. The lesson is that they are complex instruments that require careful documentation, clear governance, and — critically — a genuine alignment between buyer and seller on how the business is going to be run during the earn-out period.
An earn-out is most likely to work well when: the seller is genuinely motivated to help the buyer succeed; the earn-out metric is simple, unambiguous, and genuinely within the seller's influence; the earn-out period is short (one year is better than two, two is better than three); and the relationship between buyer and seller is strong enough to survive the inevitable moments of tension.
An earn-out is most likely to go wrong when: the seller feels they are being forced into it rather than choosing it; the metric is complex, group-dependent, or subject to adjustments the seller cannot control; the buyer plans to make significant changes to the business in the earn-out period; or the relationship between the two parties is primarily transactional rather than genuinely collaborative.
In the deal described here, almost all of the warning signs were present. The earn-out was the structure that allowed the deal to complete — but a better outcome for both parties might have been a lower completion price with no earn-out, or a vendor loan structure that did not create the same governance tensions. Hindsight is easy. But the framework for evaluating these trade-offs is available before completion — and applying it carefully is worth the time.
Learn From Other People's Earn-Out Disputes
Earn-out disputes are expensive, time-consuming, and corrosive to businesses and relationships. The best way to avoid them is to understand the structural problems that create them — before you agree the deal, not after it starts to unravel.
Our deal structuring guide covers earn-out mechanics in detail, including the key terms to negotiate and the questions to ask before you agree to a contingent payment structure. If you are looking at a deal that involves an earn-out, read it before you get to heads of terms.
And if you want a frank, experienced view on whether the earn-out structure in a deal you are looking at is well-constructed — or whether you are about to sign yourself into four years of argument — get in touch directly.
Download the Deal Structure Cheat Sheet at www.DealwiseAdvisory.co.uk
Contact Steve at [email protected] for a direct conversation about your deal structure
WhatsApp Steve on +44 7930-857243
