The Earnout Trap: Why Founders Are Signing Away Millions They Will Never See

One-third of private M&A deals now include earnouts - and in 2024, sellers received just 21 cents for every dollar of promised contingent consideration.

By Carry and Conquer Publications

The headline says acquisition. The press release says exit. But for a growing number of founders who have sold their companies in the post-2021 M&A market, the real story begins the day after closing - when the buyer takes operational control, starts making decisions that make the earnout targets unreachable, and the founder realizes that the money they thought they were getting was never really guaranteed at all. According to SRS Acquiom's 2025 M&A Deal Terms Study, earnouts in non-life-sciences deals paid out just 21 cents on the dollar in 2024. The gap between what founders thought they sold their companies for and what they actually received has quietly become one of the most significant wealth destruction mechanisms in private markets.

What an Earnout Actually Is - and Who It Serves

An earnout is a contingent payment mechanism embedded in an acquisition agreement. The buyer pays a portion of the purchase price at closing, and agrees to pay the remainder - the earnout - only if the acquired business hits defined performance targets over a post-closing period, typically one to three years. In theory, it solves a genuine problem: buyers and sellers disagree on valuation, and the earnout bridges the gap by letting future performance determine the final price.

In practice, one-third of all private company M&A deals in 2024 included an earnout, up dramatically from 13% as recently as 2018. The surge tracks almost perfectly with the valuation hangover from 2020 and 2021, when buyers made commitments at peak multiples they can no longer justify in cash. White & Case's co-head of global M&A Kimberly Petillo-Decossard has watched the results materialize in court: earnouts, she said, tend to get very ugly down the road. The Delaware Court of Chancery - where the majority of earnout disputes are litigated - has seen a marked increase in cases as the deals signed in 2021 and 2022 reach the end of their performance windows.

The Mechanics of How Founders Get Squeezed

The earnout dispute playbook is well-documented by now. A buyer acquires a company, takes control of its operations, and then - through decisions that are individually defensible but collectively devastating to earnout achievement - makes the targets unreachable. The tactics vary. Management fees get imposed that compress EBITDA. Sales resources get reallocated to the buyer's legacy product. Key customer relationships get reassigned. The accounting methodology for revenue recognition changes. A promising new contract gets passed over because it would "muddy the waters" of a parallel financing the buyer is pursuing.

Each of these moves can be explained away as normal post-acquisition integration. Few of them are illegal in isolation. But the cumulative effect is that a founder who signed a deal at a $50 million headline value - $25 million at close, $25 million earnout - walks away with $25 million, or less, while the buyer has absorbed the business at a significant discount to the agreed price.

The Anduril Industries case, arising from its 2021 acquisition of drone company Area-I, illustrates the pattern at the extreme end. The founder of Area-I alleged in a breach of contract lawsuit that Anduril diverted the acquired company's revenues and deliberately impaired its operations to avoid paying more than $15 million in earnout consideration. Anduril disputed the characterization. The litigation dragged on for years. Whether or not the allegations were proven, the case drew a map of the terrain founders are navigating after close.

The Buyer-Friendly Architecture of Most Earnout Clauses

The structural problem runs deeper than post-closing bad faith. Most earnout clauses, as actually drafted, are significantly more favorable to buyers than sellers - a reality that becomes apparent only when a dispute arises and the contract's language is stress-tested in court.

SRS Acquiom's 2024 transaction data shows that only 5% of earnout agreements included a covenant requiring the buyer to run the business to maximize earnout payments. Only 3% included a covenant to run the business in accordance with the seller's past practice. Only 10% included a commercially reasonable efforts standard - a dramatic drop from over 30% in 2023. What most agreements do include, per the same data set, is a covenant that the buyer will take no action specifically designed to harm earnout achievement. That is a much weaker protection. It prohibits overt sabotage but says nothing about the dozens of ordinary business decisions - expense allocations, headcount changes, pricing strategy, product prioritization - that collectively determine whether a revenue or EBITDA target is hit.

The implications were tested in the Delaware Chancery Court's 2024 decision in Fortis Advisors v. Johnson & Johnson, which resulted in the largest-ever earnout damages award in Delaware history - over $1 billion - after J&J was found to have failed to use the agreed standard of efforts to develop and commercialize an acquired medical device product. The seller prevailed, but only after four years of litigation and a 10-day bench trial. The lesson most practitioners drew was not that the system works for sellers, but that the only viable protection is extremely precise drafting upfront - and that even then, a founder should expect years of expensive legal combat before seeing resolution.

The 21-Cent Reality

The aggregate picture is stark. Based on SRS Acquiom's analysis of 100 non-life-sciences M&A deals that closed in 2024, earnout payees received 21 cents for every dollar of maximum potential earnout. That means, across those transactions, roughly 79% of promised earnout consideration was never paid. The median earnout represents 31% of total deal value in non-life-sciences transactions. Which means that in a meaningful proportion of deals, founders received considerably less than two-thirds of their headline number.

For founders negotiating under pressure - often post-bridge rounds, with term sheets expiring, with investors signaling urgency - the earnout is frequently presented as the mechanism that gets the deal to the number needed. What it actually does, in the majority of cases, is allow the buyer to acquire the business at the lower cash price while giving the seller a lottery ticket on the upside. The lottery pays off 21% of the time.

What Sophisticated Sellers Now Demand

The M&A legal community has largely absorbed these lessons, even if founders still frequently do not. The emerging best practice for sellers is to treat any earnout as a secondary recovery mechanism - "gravy," in the formulation used by Whiteford Taylor & Preston's M&A practice - and to ensure the base closing payment is sufficient to justify the transaction on its own. Beyond that, sophisticated sell-side counsel now push for specific provisions that the broader market has moved away from: commercially reasonable efforts standards, operational covenants that restrict integration moves that would impair earnout targets, milestone acceleration provisions if the buyer sells or restructures the acquired business, and defined accounting methodologies that cannot be altered post-close.

The metrics matter enormously. Revenue-based earnouts are generally more protective for sellers than EBITDA-based ones, because a buyer can inflate costs to suppress EBITDA while leaving revenue intact. Non-financial milestones - employee retention benchmarks, product development completions, customer contract renewals - remove accounting discretion entirely, though they introduce their own definitional disputes. The deal community is also increasingly moving toward shorter earnout periods: fewer deals in 2024 had earnout windows longer than four years, a recognition that longer horizons compound both uncertainty and the buyer's operational influence.

The Structural Takeaway for Capital Allocators

For private equity sponsors who are selling portfolio companies with earnout components, and for founders approaching an exit in a market where earnouts have become structurally normalized, the data creates a clear imperative: the earnout number is not the deal number. The deal number is the closing consideration.

This reframes the negotiation entirely. A seller accepting a $20 million close plus a $30 million earnout is not doing a $50 million deal. They are doing a $20 million deal with an option on $30 million more - an option that, based on recent market data, is worth approximately $6.3 million in expected value. Framing the negotiation that way changes what concessions are worth making to get the headline number higher versus protecting the close consideration. It also changes what a seller should demand in earnout covenant protections, given that those protections are the primary lever available to close the gap between the theoretical earnout and the actual payout.

The earnout market is not going away. With valuation gaps persisting, macro uncertainty continuing, and private equity sponsors under pressure to transact, earnouts will remain a feature of the M&A landscape. But the founders signing them in 2025 are doing so with a decade of litigation precedent and transaction data now available that makes the risk entirely legible. The only question is whether they read it before they sign.