CRA’s Rahul Chhabra provides a concise overview of earnouts in mergers and acquisitions in this CRA Insights, highlighting their role in bridging valuation gaps and managing risk, especially in private company acquisitions and in high uncertainty industries, like healthcare and technology.
He examines a recent Delaware Supreme Court case between Johnson & Johnson and Auris Health, Inc., illustrating how courts would uphold the negotiated terms of earnout agreements and not reallocate risk through ex-post implied covenant arguments.
Below are key takeaways that summarize the main legal and economic lessons from the case and the broader use of earnouts in M&A transactions:
Key takeaways
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Earnouts help buyers and sellers share risks and bridge valuation gaps by linking payments to future results, especially in private company acquisitions and in industries characterized by high uncertainty like healthcare and technology.
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Over the past six years, earnouts have consistently accounted for roughly one-quarter of deal consideration, ranging between ~22–28% of total deal value.
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There exists an inverse relationship between deal size and earnout proportion, with smaller deals, where information asymmetries are typically greater, relying more heavily on earnouts.
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Most earnout disputes arise because of disagreements over either the measurement of performance goals or whether missed performance targets are due to buyer actions or outside factors.
In earnout disputes, careful financial analysis is critical to assess whether buyer’s accounting and operational choices were reasonable given the facts and circumstances of the case.
Read more about earnouts in M&A here.
