The Data Lockout: Managing Post-Closing Reporting Risk

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M&A Stories

January 12, 2026

One Question

If your buyer fails to meet a specific deadline for calculating your earnout or final sale price, does that automatically mean they lose their right to use an outside accountant to settle the dispute?

In the lower middle market, the period immediately following a sale involves a significant shift in information control. For a seller, this transition can create a “black box” where the new owner controls the data used to determine the final purchase price. A recent Delaware Court of Chancery decision illustrates the risks when a sophisticated Private Equity (PE) buyer misses a reporting deadline, changes the accounting methodology, and restricts the seller’s access to financial records.

The Facts: System Migration and Data Dumps

The case involved a service business sold to a PE-backed buyer. The deal included a $1 million earnout based on a performance period ending near the closing date. The Membership Interest Purchase Agreement required the buyer to prepare a final balance sheet within 120 days of the closing, but it notably lacked an explicit requirement to deliver that balance sheet to the seller within that same window.

Post-closing, the buyer’s management team took full control of the financial systems. They hired a new controller, migrated the company’s accounting from a Cash Basis to an Accrual Basis, and terminated the seller’s access to the accounting system.

While the buyer was technically obligated to deliver an earnout statement, they missed the 120-day mark. Twelve days after that deadline, they provided the seller with several unorganized spreadsheets—including a 262MB raw data file—that the seller claimed could not be opened and did not constitute a formal “statement” under the purchase agreement. The seller sued to compel the immediate release of the escrow funds, arguing that the buyer’s delay, coupled with the lack of transparency, constituted a waiver of the buyer’s rights.

The seller found themselves in a difficult position: they were locked out of the books, the buyer was changing the accounting rules, and the buyer was attempting to use the contract’s “Neutral Accountant” process to settle a dispute that was more about procedural non-compliance than simple math errors.

The Fix: Protecting Financial Integrity Post-Closing

The seller could have managed this litigation and arbitration risk during the pre-closing phase by ensuring the buyer did not have total discretion over the post-closing environment. To protect the integrity of your payout, consider the following tools:

Mandatory Information Access Rights: Secure a contractual right to “read-only” access to the accounting platform (e.g., ERP or QuickBooks Online) until the earnout is finalized. This prevents the buyer from claiming the seller caused delays and allows the seller to audit the data in real-time.

Consistency of Accounting Covenant: Explicitly require that the earnout be calculated using the same accounting principles and “past practices” used by the seller historically. This prevents the buyer from using a shift from cash to accrual accounting to suppress reportable profit.

Cure Period with Deemed Acceptance: Negotiate a provision stating that if the buyer fails to deliver a compliant statement on time, the seller provides a 5-day notice. If the buyer remains in default after 5 days, the Seller’s Closing Estimate becomes the final and binding figure.

Reporting Standards and Formats: Define the “Earnout Statement” to require specific, standard financial reports (Balance Sheet, P&L, and General Ledger) rather than allowing the buyer to satisfy the requirement by providing raw data or unlinked workbooks.

Why This Matters

For sophisticated sellers and their advisors, the lesson is that a Neutral Accountant cannot fix a broken reporting process. If the buyer controls the systems and the schedule, they can effectively paralyze the payout process. By securing information transparency and accounting consistency in the purchase agreement, sellers ensure the earnout remains a measure of performance rather than a measure of the buyer’s accounting discretion.

C.A. No. 2025-0639 KMM, Court of Chancery of Delaware (January 7, 2026)

Thank you for reading this blog. If you have any questions, insights, or if you’d like to engage in a more detailed discussion on this matter, I invite you to reach out directly.

Feel free to send me an email. I value thoughtful discussions and am always open to connecting with business owners, management, as well as professionals who share an interest in the complexities of M&A law in lower middle market private target deals.

By John McCauley: I write about recent problems of buyers and sellers in lower middle market private target deals.

Email: jmccauley@mk-law.com

Profile: http://www.martindale.com/John-B-McCauley/176725-lawyer.htm

Telephone:      714 273-6291

Check out my books: Buying Established Business Assets: A Guide for Owners, https://www.amazon.com/dp/B09TJQ5CL5

and Advisors and Selling Established Business Assets: A Guide for Owners and Advisors, https://www.amazon.com/dp/B0BPTLZNRM

Legal Disclaimer

The blogs on this website are provided as a resource for general information for the public. The information on these web pages is not intended to serve as legal advice or as a guarantee, warranty or prediction regarding the outcome of any particular legal matter. The information on these web pages is subject to change at any time and may be incomplete and/or may contain errors. You should not rely on these pages without first consulting a qualified attorney.

Posted in enforcing buyer earnout deadlines, problems with earnouts Tagged with: , , , , , , , , , ,

Payout Denied: Why This Seller’s Earnout Claim Failed at the Dismissal Phase

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M&A Stories

January 11, 2026

One Question

If a buyer with multiple subsidiaries moves your legacy customers and star salespeople to a different branch of their company, does your earnout contract contain the specific “if/then” rules required to prove a breach of contract, or are you relying on a judge’s definition of “fairness”?

The seller in this case operated a specialized technology firm focused on cloud-based communication systems. The buyer was a national technology conglomerate with a complex structure of various business branches and subsidiaries.

In this deal, the seller was absorbed into a large corporate machine. The danger realized here was that the buyer moved the revenue-generating assets—the customers and the star employees—into different business units that were not included in the earnout calculation. Because the earnout was tied only to the profits of the specific entity that was sold, the buyer was able to shift the revenue out of the seller’s reach without technically violating the written contract.

The judge dismissed the seller’s claims because the contract gave the buyer “sole discretion” to run the business. Without specific, objective guardrails, the court refused to override the buyer’s management decisions. To avoid this outcome, a seller must have specific rules that act as a tether between their former assets and their earnout payout.

Facts

The seller provided specialized IT and cloud services. The buyer, a national provider with numerous subsidiaries, purchased the seller’s assets for an upfront payment plus a three-year earnout based on future profits.

After the deal closed, the buyer integrated the business. The seller alleged the buyer moved sales staff and customer accounts to other companies the buyer already owned. This shifted the revenue away from the seller’s specific earnout calculation. The seller sued for “bad faith,” but the buyer pointed to a clause in the contract giving them “sole discretion” over all business operations and stating they had no obligation to maximize the earnout.

Issues

The primary issue was the hollowing out of the business unit. The Delaware Superior Court had to decide if a buyer could move the people and customers that generate an earnout to a different subsidiary to avoid paying the seller. Additionally, the court addressed the fairness argument, determining if a general requirement to act in “good faith” overrides a specific contract clause that gives the buyer “sole discretion.”

Decision

The court ruled in favor of the buyer and granted the motion to dismiss. There was no earnout protection for the seller regarding the moved accounts and staff. The court held that the contract language was the final word and that the seller could not use a fairness argument to create protections they did not negotiate.

Reasons

The court focused on the power of the “Sole Discretion” clause. The contract explicitly stated the buyer had no obligation to take any action to maximize the earnout. Delaware courts do not rescue sophisticated sellers from lopsided deals if the contract allows the buyer’s behavior. Furthermore, the court noted that the “implied covenant of good faith” only fills unexpected gaps. Since the parties could have written a rule about moving staff or customers but did not, the court refused to create one.

Strategic Lessons for the Seller

This case demonstrates that in a strategic acquisition, your biggest competitor for the earnout might be the buyer’s other business divisions. It highlights an integration risk where a buyer can follow the literal letter of the contract while effectively zeroing out your payout by shifting resources. Relying on “good faith” or “fairness” is not a reliable safety net; protection must be built into the contract as an objective, financial rule.

Recommended Covenants

To help survive a motion to dismiss, a seller must be able to point to a specific, objective rule that was broken. Relying on “bad faith” is often a losing strategy at the start of a case because it is difficult to prove without a full trial. These two covenants would have helped the seller’s legal position.

The “Follow the Customer” Rule

The contract should identify a specific list of the seller’s customers at the time of closing. The rule must state that any sale made to a customer on that list—whether by the buyer, the target company, or any other subsidiary the buyer owns—must be credited to the seller’s earnout. This ensures the revenue is tracked by the identity of the customer rather than the identity of the office sending the invoice. It makes the buyer’s corporate structure irrelevant to the math of the earnout.

The “Stay-Put” Rule for Key Employees

The contract should name key employees and strictly forbid the buyer from transferring them away from the specific business unit being measured for the earnout. If the buyer moves a key person to a different branch or promotes them out of the unit, the contract should trigger an automatic, pre-calculated credit to the earnout total. This prevents the buyer from removing the talent necessary to hit the profit targets and provides a clear fact for a judge to evaluate during a motion to dismiss.

C.A. Nos. N16C-12-032 MMJ CCLD, N19C-02-141 MMJ CCLD, Superior Court of Delaware (September 17, 2019)

Thank you for reading this blog. If you have any questions, insights, or if you’d like to engage in a more detailed discussion on this matter, I invite you to reach out directly.

Feel free to send me an email. I value thoughtful discussions and am always open to connecting with business owners, management, as well as professionals who share an interest in the complexities of M&A law in lower middle market private target deals.

By John McCauley: I write about recent problems of buyers and sellers in lower middle market private target deals.

Email: jmccauley@mk-law.com

Profile: http://www.martindale.com/John-B-McCauley/176725-lawyer.htm

Telephone:      714 273-6291

Check out my books: Buying Established Business Assets: A Guide for Owners, https://www.amazon.com/dp/B09TJQ5CL5

and Advisors and Selling Established Business Assets: A Guide for Owners and Advisors, https://www.amazon.com/dp/B0BPTLZNRM

Legal Disclaimer

The blogs on this website are provided as a resource for general information for the public. The information on these web pages is not intended to serve as legal advice or as a guarantee, warranty or prediction regarding the outcome of any particular legal matter. The information on these web pages is subject to change at any time and may be incomplete and/or may contain errors. You should not rely on these pages without first consulting a qualified attorney.

Posted in Cross-Selling Earnout Credit, Key Employee Retention Requirement, problems with earnouts, robust objective buyer earnout covenants Tagged with: , , , , , , , , , , , , ,

Get Earnout Credit for Selling the Buyer’s Products: Don’t Let the Buyer “Borrow” Your Sales Team for Free

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M&A Stories

January 10, 2026

One Question

If your sales team starts selling the Buyer’s existing products after the deal closes, does your contract explicitly state that those sales count toward your earnout, or are you accidentally working for the Buyer for free?

The Facts

The Seller owned an investment firm, which we will call the Target. The Seller sold the Target to a large Buyer via a merger for $6.25 billion upfront. The deal included an earnout of up to $278 million, which the Seller would receive if the Target hit specific growth targets over three years.

To understand this dispute, you have to look at how the Target earned its money. In this industry, the firm generates revenue by charging an annual Management Fee—typically around 1%—to manage a customer’s money. The firm’s technical experts do the “heavy lifting” by managing the funds, but the sales team does the work of finding the clients and getting them to invest. The dispute here is about who gets “credit” toward the earnout for that 1% fee when a Target salesperson puts a client into a Buyer’s fund instead of a Target fund.

After the sale, the Buyer and Target merged their operations. The Target had a world-class sales team, and the Buyer quickly put them to work selling the Buyer’s own investment products. The team was highly successful and brought in a massive amount of new money for the Buyer.

However, when it came time to pay the earnout, the Buyer refused to count any of those sales. The contract actually contained a rule saying the Seller would get 50% credit for products where the Buyer was involved. But the Buyer argued this 50% rule only applied to jointly-run products where the Target was the main manager. They claimed that since these were “pure” Buyer funds, the 1% management fee belonged entirely to the Buyer and didn’t count toward the earnout at all. Because the team spent so much time selling the Buyer’s products instead of the Target’s products, the Target missed its growth targets, and the Buyer used this to justify not paying over $100 million of the earnout to the Seller.

The Seller sued the Buyer in the Delaware Court of Chancery.

The Issue

The primary issue is whether the Seller gets credit toward the earnout for selling the Buyer’s products and putting customers into the Buyer’s funds.

The Decision

The court denied the Buyer’s motion to dismiss, allowing the Seller to take the case to trial. The judge ruled that the contract was ambiguous, or unclear. She found that the Seller’s interpretation—that they should get credit for the act of selling any products—was just as reasonable as the Buyer’s more restrictive view.

The Reasons

The judge looked at the specific wording of the deal, which used the word “distributed.” In this industry, “distributing” means the act of finding a customer and making a sale. Because the contract didn’t explicitly say “only products owned by the Target before the deal,” the court ruled that the Seller had a valid argument for receiving credit for selling the Buyer’s products. To solve the “tie,” the court ordered a review of the background emails and notes from the original negotiations to see what the parties really intended.

How to Manage This Risk Before Closing

The mistake here was assuming that “a sale is a sale.” The Seller didn’t realize that a Buyer might redirect the Target’s sales team to grow the Buyer’s legacy business, which can leave the Target’s specific earnout targets underfunded and out of reach.

To manage this risk, Sellers should insist on a schedule that lists exactly how much credit the Seller gets toward their earnout for every dollar brought in, regardless of whether it is a Target product or a Buyer product. This ensures the Seller is fairly rewarded for the team’s effort and aligns the interests of both parties when the Buyer chooses to utilize the Target’s sales force for its own products.

C.A. No. 2018-0419-MTZ, Court of Chancery of Delaware (July 26, 2019)

Thank you for reading this blog. If you have any questions, insights, or if you’d like to engage in a more detailed discussion on this matter, I invite you to reach out directly.

Feel free to send me an email. I value thoughtful discussions and am always open to connecting with business owners, management, as well as professionals who share an interest in the complexities of M&A law in lower middle market private target deals.

By John McCauley: I write about recent problems of buyers and sellers in lower middle market private target deals.

Email: jmccauley@mk-law.com

Profile: http://www.martindale.com/John-B-McCauley/176725-lawyer.htm

Telephone:      714 273-6291

Check out my books: Buying Established Business Assets: A Guide for Owners, https://www.amazon.com/dp/B09TJQ5CL5

and Advisors and Selling Established Business Assets: A Guide for Owners and Advisors, https://www.amazon.com/dp/B0BPTLZNRM

Legal Disclaimer

The blogs on this website are provided as a resource for general information for the public. The information on these web pages is not intended to serve as legal advice or as a guarantee, warranty or prediction regarding the outcome of any particular legal matter. The information on these web pages is subject to change at any time and may be incomplete and/or may contain errors. You should not rely on these pages without first consulting a qualified attorney.

Posted in Cross-Selling Earnout Credit, problems with earnouts Tagged with: , , , , , , , ,

Setting Objective Buyer Covenants to Secure Your FDA and EC Earnout Milestones

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M&A Stories

January 9, 2026

When you sign a deal with an earnout, you are essentially betting on the buyer’s future performance. The One Question for every seller is this: Does your contract require the buyer to complete the specific, mandatory steps needed for FDA and European Commission approval, or are you just relying on aspirational buyer efforts clauses?

A small startup developed a specialized antibody with the potential to treat severe respiratory and digestive conditions. A mid-sized pharmaceutical company saw the value and bought the business, promising the founders $550 million in earnout milestones if the product cleared the regulatory finish lines with both the FDA in the U.S. and the European Commission (EC) in Europe.

The partnership started as a major success. The buyer hit the first set of goals, proving the technology worked, and sent the founders a $200 million check.

But the story shifted. Soon after, a global giant acquired the original buyer for $6.8 billion. Suddenly, the startup’s project wasn’t just competing for attention inside a mid-sized company; it was a tiny line item in a massive global corporation that had 1,500 other products to launch and billions in new debt to manage.

Even though the first milestones had been met, the new global owners let the work on the remaining U.S. and European approvals slow to a crawl. The buyers eventually sent a letter essentially pulling the plug. They argued that because they had so many new global priorities, it was no longer “reasonable” to spend money on this specific project. They claimed their “discretion” to run the company gave them the right to walk away from the remaining milestones.

The Post-Mortem: Why “Reasonableness” Failed

The founders sued the buyer in the Delaware Court of Chancery to protect the remaining $350 million. They only survived the attempt to throw the case out because they had a clause requiring the buyer to act like other “similarly situated” companies. The founders had to point to four competitors who were still successfully pursuing the same FDA and EC approvals to prove the buyer was neglecting the project in favor of its other interests.

While the founders stayed in the fight, they were trapped in a multi-year legal battle because they relied on a “reasonableness” standard. If they had replaced that vague language with objective buyer covenants specifically tied to the necessary steps for global approval, the buyer’s legal position would have been significantly weaker, likely forcing a much faster resolution.

Converting Vague Promises into Objective Buyer Covenants

To protect your earnout from a buyer who might pivot—or a second buyer who might acquire your original buyer—you need to strip away their “discretion” by using clear, measurable triggers. In a deal dependent on global approvals, these objective buyer covenants can shift the burden of proof from the seller to the buyer.

The Data Filing Deadlines

In this case, the buyer sat on completed study data for years without sending it to the regulators. An objective covenant should have required the buyer to file all study results with the FDA and the EC within 60 days of completion. This is a “Yes/No” test that a judge can verify without hearing excuses about the buyer’s other global projects.

Mandatory Enrollment in “Fast-Track” Programs

Both the U.S. and Europe have established pathways designed to speed up the review of important new drugs. A savvy seller’s team knows these exist and should make it a mandatory rule that the buyer apply for these “priority” spots in every relevant country as soon as the drug qualifies. This gives the sellers a clear “gotcha” moment: either the buyer applies by the deadline, or they have officially broken the contract.

The Clinical Trial Floor

The buyer claimed they couldn’t afford the next phase of testing. An objective covenant could have required the buyer to enroll a minimum number of patients in clinical trials across both the U.S. and Europe by a specific date. This turns a global budget decision into a contractual mandate.

By using these specific measures, you move the conversation from “why the buyer changed their mind” to “did the buyer take the steps required by the contract.” Objective covenants turn an aspirational promise into a hard obligation that the buyer cannot ignore.

C.A. No. 2018-0075-SG, Court of Chancery of Delaware (December 28, 2018)

Thank you for reading this blog. If you have any questions, insights, or if you’d like to engage in a more detailed discussion on this matter, I invite you to reach out directly.

Feel free to send me an email. I value thoughtful discussions and am always open to connecting with business owners, management, as well as professionals who share an interest in the complexities of M&A law in lower middle market private target deals.

By John McCauley: I write about recent problems of buyers and sellers in lower middle market private target deals.

Email: jmccauley@mk-law.com

Profile: http://www.martindale.com/John-B-McCauley/176725-lawyer.htm

Telephone:      714 273-6291

Check out my books: Buying Established Business Assets: A Guide for Owners, https://www.amazon.com/dp/B09TJQ5CL5

and Advisors and Selling Established Business Assets: A Guide for Owners and Advisors, https://www.amazon.com/dp/B0BPTLZNRM

Legal Disclaimer

The blogs on this website are provided as a resource for general information for the public. The information on these web pages is not intended to serve as legal advice or as a guarantee, warranty or prediction regarding the outcome of any particular legal matter. The information on these web pages is subject to change at any time and may be incomplete and/or may contain errors. You should not rely on these pages without first consulting a qualified attorney.

Posted in earnouts based upon fda/ec milestones, problems with earnouts Tagged with: , , , , , , , , , ,

The Critical Need for Robust and Objective Buyer Construction Milestones for Earnouts

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M&A Stories

January 8, 2026

One Question

If your payout depends on the buyer building a facility or hitting a production goal, does your contract explicitly mandate the funding and equipment purchases, or are you relying on a “plan” the buyer can change?

In a significant M&A dispute, a seller learned that standard legal language and operational plans can be interpreted in multiple ways, leading to years of litigation rather than a scheduled payout.

The deal involved a buyer acquiring a company for $25 million upfront, with an additional $30 million tied to two milestones. These milestones involved building a small-scale pilot plant and then a large-scale commercial plant. To reach these goals, the buyer needed to order a specific, expensive piece of equipment immediately after closing.

The buyer delayed ordering the equipment, claiming they needed to go through internal corporate approval processes. Because of this delay, the deadlines for the milestones passed, the plants were not finished, and the buyer refused to pay the $30 million.

The Facts

The seller sued, pointing to two specific parts of the agreement. First, they highlighted the Authority Representation, where the buyer represented they had already taken all corporate action necessary to perform their obligations. The seller argued this meant the money for the equipment was already approved. Second, they pointed to the Operational Plan, which included a schedule for hiring staff and spending money. The seller argued this was a mandatory roadmap the buyer had to follow.

The buyer argued that the plan was just a guideline and that the authority representation was just standard legal boilerplate that did not override their internal budget process.

The Decision

The court refused to dismiss the case. It ruled that the contract was ambiguous. Because the milestone payments were such a large part of the total deal value, the court found it was reasonable to believe the seller intended for the plan to be a binding commitment and for the authority representation to mean the buyer was ready to spend the money on day one.

The Reasons

The court noted that the buyer represented they could perform their obligations, not just close the deal. In a deal built on milestones, performance includes the steps needed to hit those targets. Additionally, attaching a detailed budget and headcount schedule to a contract can elevate it from a forecast to a set of mandatory instructions.

The Non-Obvious Pre-Closing Risk

This case highlights the risk that a buyer may not have fully factored its internal budgeting and procurement processes into the deal timeline. While the deal team may be ready to move, the buyer’s internal bureaucracy can inadvertently stall a project. Even with sophisticated buyers like private equity firms or large corporations, a standard authority representation may not provide enough clarity to ensure that equipment is ordered or staff are hired the day after closing.

The Fix

To manage this risk pre-closing, a seller should require a specific covenant that mandates the purchase of critical equipment by a certain date. They should also include a closing condition requiring proof that the buyer’s board has already authorized the specific capital expenditures needed for the milestones. Finally, the agreement should explicitly state that the financial and human resource schedules are mandatory obligations rather than just aspirational guidelines.

C.A. No. 12291-VCS, Court of Chancery of Delaware (August 10, 2018)

Thank you for reading this blog. If you have any questions, insights, or if you’d like to engage in a more detailed discussion on this matter, I invite you to reach out directly.

Feel free to send me an email. I value thoughtful discussions and am always open to connecting with business owners, management, as well as professionals who share an interest in the complexities of M&A law in lower middle market private target deals.

By John McCauley: I write about recent problems of buyers and sellers in lower middle market private target deals.

Email: jmccauley@mk-law.com

Profile: http://www.martindale.com/John-B-McCauley/176725-lawyer.htm

Telephone:      714 273-6291

Check out my books: Buying Established Business Assets: A Guide for Owners, https://www.amazon.com/dp/B09TJQ5CL5

and Advisors and Selling Established Business Assets: A Guide for Owners and Advisors, https://www.amazon.com/dp/B0BPTLZNRM

Legal Disclaimer

The blogs on this website are provided as a resource for general information for the public. The information on these web pages is not intended to serve as legal advice or as a guarantee, warranty or prediction regarding the outcome of any particular legal matter. The information on these web pages is subject to change at any time and may be incomplete and/or may contain errors. You should not rely on these pages without first consulting a qualified attorney.

Posted in earnouts based on construction milestones, problems with earnouts Tagged with: , , , , , , , , ,

Don’t Sign Your M&A Deal Until the Buyer Is Ready to Close

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M&A Stories

January 5, 2026

One Question

If you sign the final deal documents before the buyer is financially ready to close, have you effectively surrendered your best defense against being sued for the entire value of the deal if the buyer stalls?

Every business owner knows that a handshake isn’t a final contract. In a typical lower middle market deal, the goal is a simultaneous closing: you sign the papers, they wire the money, and the keys change hands at the same moment. This is the cleanest, least risky way to sell your business because the “show me the money” moment happens exactly when you commit.

However, a recent court battle involving a major technology company reveals how easily a seller can accidentally give away that protection. In this case, the seller made a high-stakes mistake. Even though the buyer had not yet proven they had the funds, the seller went ahead and signed the final deal documents. They placed the signatures in a holding account, thinking they were just being efficient and getting ready for the big day.

By signing early, the seller invited the kind of risk usually reserved for a deferred closing, where a long period passes between signing and the actual exchange of cash. They essentially handed the buyer a reason to argue that the deal was final and binding. When the buyer failed to come up with the cash by the deadline, and the seller tried to move on, the buyer used those signed documents as a hook for a lawsuit. They did not just sue for their wasted time; they sued for the millions of dollars in profit they expected to make from owning the company.

The seller was forced into years of expensive litigation to prove that those signatures should not count. While the seller eventually won on technicalities in their paperwork, the entire ordeal could have been avoided by following one simple rule: never sign until the buyer is ready to pay.

The lesson for any owner is simple: the “show me the money” moment is your greatest point of leverage. When you sign before the buyer is financially ready to close, you are giving away your most powerful pre-closing risk management tool. By keeping your pen in your pocket until the wire transfer is ready to go, you maintain the strongest possible position to move toward a backup buyer once your legal obligations to the first one have ended.

No. 24-2794, United States Court of Appeals, Seventh Circuit (December 23, 2025)

Thank you for reading this blog. If you have any questions, insights, or if you’d like to engage in a more detailed discussion on this matter, I invite you to reach out directly.

Feel free to send me an email. I value thoughtful discussions and am always open to connecting with business owners, management, as well as professionals who share an interest in the complexities of M&A law in lower middle market private target deals.

By John McCauley: I write about recent problems of buyers and sellers in lower middle market private target deals.

Email: jmccauley@mk-law.com

Profile: http://www.martindale.com/John-B-McCauley/176725-lawyer.htm

Telephone:      714 273-6291

Check out my books: Buying Established Business Assets: A Guide for Owners, https://www.amazon.com/dp/B09TJQ5CL5

and Advisors and Selling Established Business Assets: A Guide for Owners and Advisors, https://www.amazon.com/dp/B0BPTLZNRM

Legal Disclaimer

The blogs on this website are provided as a resource for general information for the public. The information on these web pages is not intended to serve as legal advice or as a guarantee, warranty or prediction regarding the outcome of any particular legal matter. The information on these web pages is subject to change at any time and may be incomplete and/or may contain errors. You should not rely on these pages without first consulting a qualified attorney.

Posted in problems with simultaneous closings, signature escrows are risky Tagged with: , , , , , , , , ,

The Fatal Procedural Flaw in an Earn-Out Calculation Formula: An Agreement to Agree

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M&A Stories

January 3, 2026

One Question: Does your earn-out provision rely on a “mutual agreement” to include revenue from the buyer’s future acquisitions, and if so, what is the default result if you never reach that agreement?

In many lower middle market deals, an earn-out is the only way to close a valuation gap. The seller wants a higher price, and the buyer is willing to pay it, but only if the business performs after the sale. In one notable case, the sellers of a healthcare services company agreed to a deal worth $13.5 million in cash, with the potential for much more if their business unit hit a revenue target of $47.2 million.

To understand the dispute, you have to understand exactly what the acquired business does on a daily basis. This company was essentially a back-office engine for the medical industry. Their daily business activities included credentialing, which involves verifying that doctors have the right licenses and clean records. They also handled claims administration by checking medical bills against insurance policies to ensure the right people got paid. Additionally, they performed the data processing required to organize messy digital files for insurance computers and managed the billing and collection of insurance premiums.

The Procedural Error Regarding Acquisitions

Because the buyer was a large corporation, everyone involved knew they would likely buy similar companies after the deal closed. The buyer and seller agreed that revenue from similar companies would be included as revenue in the earnout calculation. The sellers were savvy enough to include a specific definition of what a similar business looked like in the contract, based on the activities mentioned above. However, they made a critical error in how that list was applied.

Instead of making the inclusion of new revenue automatic based on that definition, the contract stated that the parties would negotiate in good faith to determine if a future acquisition actually fit that definition. Most importantly, the contract included a fallback rule: until the parties reached a mutual agreement, that revenue would not be included. When the time came to collect the earn-out, the buyer argued the targets were not met. While they had acquired new companies, they simply refused to agree that those revenues fit the definition. The sellers, left with no earn-out payment, filed a lawsuit in a Delaware federal district court.

The Court’s Dismissal

The court dismissed the sellers’ claims. The judge ruled that the buyer did not breach the contract by failing to include the acquisition revenue. The reasoning was straightforward: even though the contract already had a list of similar services, the sellers still agreed that they needed a new agreement to apply that list to any future purchase. Since the parties had not reached that second agreement, the default rule kicked in and the revenue was excluded. The court essentially told the sellers that because they left the door open for a future negotiation, the buyer was legally allowed to say no, and the implied covenant of good faith could not override that specific contract right.

A Better Way to Manage Pre-Closing Risk

To manage this risk pre-closing, you must ensure that your service list acts as an automatic trigger. The mistake here was not the list itself, but the requirement for a mutual agreement to use it. You should never leave the final determination of an earn-out to a future conversation. Even if you feel you have limited leverage, accepting an agreement to agree is often the same as accepting nothing at all.

Your contract should state that any revenue from a new acquisition shall be included if the acquired company performs the specific services you have already identified. If there is a dispute over whether a new acquisition fits the list, the contract should point to a neutral third-party expert for a binding decision, rather than defaulting to zero in the absence of an agreement. By removing the requirement to negotiate later, you take away the buyer’s power to block your payment. If the buyer buys a company that performs the services on your list, the math becomes automatic.

Civ. No. 15-419-LPS, United States District Court, D. Delaware (March 29, 2016)

Thank you for reading this blog. If you have any questions, insights, or if you’d like to engage in a more detailed discussion on this matter, I invite you to reach out directly.

Feel free to send me an email. I value thoughtful discussions and am always open to connecting with business owners, management, as well as professionals who share an interest in the complexities of M&A law in lower middle market private target deals.

By John McCauley: I write about recent problems of buyers and sellers in lower middle market private target deals.

Email: jmccauley@mk-law.com

Profile: http://www.martindale.com/John-B-McCauley/176725-lawyer.htm

Telephone:      714 273-6291

Check out my books: Buying Established Business Assets: A Guide for Owners, https://www.amazon.com/dp/B09TJQ5CL5

Selling Established Business Assets: A Guide for Owners and Advisors, https://www.amazon.com/dp/B0BPTLZNRM

Legal Disclaimer

The blogs on this website are provided as a resource for general information for the public. The information on these web pages is not intended to serve as legal advice or as a guarantee, warranty or prediction regarding the outcome of any particular legal matter. The information on these web pages is subject to change at any time and may be incomplete and/or may contain errors. You should not rely on these pages without first consulting a qualified attorney.

Posted in agreement to agree on earnout revenue inclusion, problems with earnouts Tagged with: , , , , , , , , , ,

The 11th Hour Buyer Pivot from All-Cash to a Significant Earnout

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M&A Stories

January 2, 2026

When you are close to finalizing a business sale, any sudden change to the payment structure is a message from the buyer. In a Delaware Court of Chancery case, a seller had developed a niche service that allowed consumers to trade in their used video games at a retail video game store in exchange for digital gift cards. This trade-in model was a unique bridge that solved a problem for both the video game chain and the restaurant brands featured on the cards.

The primary driver of the company’s valuation was a pending partnership with a massive national retailer—a chain of hundreds of physical video game stores. The seller had spent over a year working directly with this video game chain to supply these trade-in cards, and the project was expected to generate millions in profit. However, the gift card distribution industry was dominated by two massive giants. While the buyer was one of these giants, the video game store already used the other giant as its primary supplier to manage the main gift card racks at the front of every store.

The One Question

If the buyer suddenly asks to move guaranteed cash into a pay-later arrangement for your most important customer, have you asked them exactly what they see in your relationship with that customer that makes them want to shift the risk?

This anticipated growth from the trade-in program was the reason the buyer originally offered a significant all-cash payout. However, 19 days before closing, the buyer asked to change the deal. They wanted to move millions of dollars from the guaranteed cash payment into an earnout that would only be paid if that specific contract with the video game store actually launched and hit certain targets.

A significant change in deal terms right before the final signatures are collected is a massive red flag. It is a signal that the buyer has identified a specific risk they are no longer willing to cover. In this case, the hidden problem was that its main competitor supplied most gift cards to the video game chain under a contract that prohibited the chain from buying from the buyer or any company the buyer owned.

The buyer also prohibited its customers from dealing with this competitor. So, it was surprising that the buyer did not propose the earnout structure earlier. Rather than admitting the problem, the buyer shifted the financial risk to the seller by turning guaranteed cash into a payout that depended on a successful launch.

The seller agreed to the earnout, not knowing of the problem, and the deal with the video game chain did not happen after closing. This led to the seller suing the buyer for fraud and negligent misrepresentation. The buyer asked the court to dismiss the claims. Although the court refused to dismiss the seller’s claim, the seller now must go through the gauntlet of litigation to try to collect damages.

By asking why the buyer requested the last-minute change, the seller could have forced the buyer to explain their sudden concern. If the buyer cannot provide a satisfactory explanation for the shift, and the seller cannot independently verify that the risk is manageable, the seller has a few clear paths.

One option is to insist on the original all-cash deal. If the buyer’s own corporate baggage is the problem, the buyer should be the one to pay for it. Another option is to simply walk away. If a buyer refuses to keep the money guaranteed, they are effectively admitting that the project is in jeopardy.

Walking away from a deal at the 11th hour is difficult, but it may be the only way to protect the value of the business. In this instance, the seller might have been better off remaining independent or even approaching the competitor who actually held the keys to the store.

C.A. No. 10851-VCN, Court of Chancery of Delaware (February 26, 2016)

Thank you for reading this blog. If you have any questions, insights, or if you’d like to engage in a more detailed discussion on this matter, I invite you to reach out directly.

Feel free to send me an email. I value thoughtful discussions and am always open to connecting with business owners, management, as well as professionals who share an interest in the complexities of M&A law in lower middle market private target deals.

By John McCauley: I write about recent problems of buyers and sellers in lower middle market private target deals.

Email: jmccauley@mk-law.com

Profile: http://www.martindale.com/John-B-McCauley/176725-lawyer.htm

Telephone:      714 273-6291

Check out my books: Buying Established Business Assets: A Guide for Owners, https://www.amazon.com/dp/B09TJQ5CL5

and Advisors and Selling Established Business Assets: A Guide for Owners and Advisors, https://www.amazon.com/dp/B0BPTLZNRM

Legal Disclaimer

The blogs on this website are provided as a resource for general information for the public. The information on these web pages is not intended to serve as legal advice or as a guarantee, warranty or prediction regarding the outcome of any particular legal matter. The information on these web pages is subject to change at any time and may be incomplete and/or may contain errors. You should not rely on these pages without first consulting a qualified attorney.

Posted in Problems with Competitors, problems with customers, problems with earnouts Tagged with: , , , , , , , ,

The Importance of Robust Buyer Objective Earnout Covenants

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M&A Stories

January 1, 2026

One Question for the Seller: Does your purchase or merger agreement list the specific resources the buyer must provide—such as sales headcount and inventory levels—or are you relying on a “best efforts” clause to bridge the gap between their promises and your earnout payout?

Experienced sellers and their advisors know that a buyer’s promise to use “best efforts” is a weak safety net. However, even smart deal teams make the mistake of picking a few specific rules to put in the contract while leaving the rest of the business operations to chance. As a dispute in the Delaware Court of Chancery shows, having only a partial list of rules can be just as bad as having no rules at all.

In this deal, the seller made sure to include some specific requirements. They forced the buyer to keep the company as a separate unit, keep the same number of engineers, and keep the pricing separate. These were good rules. But when the business missed its targets, the seller realized they hadn’t made rules for the most important things: the buyer didn’t replace the CEO when he left, they let the sales team shrink, and they didn’t keep enough inventory on the shelves. Because those specific points weren’t in the contract, the seller had no way to force the buyer to fix them.

The Risk of an Incomplete List

When a contract includes a specific list of requirements, judges often assume that if a rule isn’t on that list, you didn’t want it. By writing down a rule for engineering headcount but saying nothing about the sales team or the CEO, the seller accidentally gave the buyer a “free pass” on those other areas.

The buyer argued that as long as they followed the few rules written in the contract, every other management decision was up to them. Even though these decisions killed the earn-out, the court wouldn’t step in to help. The judge pointed out that the parties had already negotiated the specific obligations of the buyer, and the court wasn’t going to add new ones after the fact.

Finding the Holes in Your Payout Protection

To protect your payout before you sign, you need to look at exactly what needs to happen every day to hit your numbers. If you rely on a “best efforts” clause for the hard parts of running the business, you make it much harder to win a lawsuit later. You would have to prove the buyer had “bad intent,” which is almost impossible, rather than just showing they broke a clear, simple rule.

Leadership and Key Hires: Often, contracts focus on the total number of employees but ignore who is leading them. If your revenue depends on having a strong leader, the contract should state exactly how and when a departing leader must be replaced. A rule that says “you must start a search for a new CEO within 30 days” is a clear requirement; a promise to “try” to find someone is just a suggestion.

Sales and Marketing Support: Sales and marketing drive revenue, yet buyers often want total control over these departments. A strong agreement should set a floor for the number of salespeople, name the specific accounts that must be supported, and set a minimum marketing budget. Without these, a buyer can technically keep the lights on in the office while starving the sales engine that actually generates your earn-out.

Inventory and Supplies: Business owners often forget to put rules in place for inventory. If hitting your target requires selling a certain amount of product, the buyer must be required to keep enough inventory in stock to meet that goal. In the case mentioned above, a lack of inventory was a major reason the targets were missed, but the seller had no rule in the contract to prevent it.

Managing the Risk Before Closing

For a seller with good business judgment, the lesson is simple: secure your earn-out while you are still at the negotiating table. If a buyer makes promises during the sale about “growing the business” or “supporting your customers,” those promises must be turned into clear, measurable rules in the final paperwork.

A clear rule makes it easy to see when a buyer has failed. A “best efforts” promise often leads to years of expensive legal fees just to try and prove what the buyer was thinking. To protect your earn-out, identify every management decision that could cost you money and make sure each one is covered by a specific, written rule.

C.A. No. 9522-CB, Court of Chancery of Delaware (January 30, 2015).

Thank you for reading this blog. If you have any questions, insights, or if you’d like to engage in a more detailed discussion on this matter, I invite you to reach out directly.

Feel free to send me an email. I value thoughtful discussions and am always open to connecting with business owners, management, as well as professionals who share an interest in the complexities of M&A law in lower middle market private target deals.

By John McCauley: I write about recent problems of buyers and sellers in lower middle market private target deals.

Email: jmccauley@mk-law.com

Profile: http://www.martindale.com/John-B-McCauley/176725-lawyer.htm

Telephone:      714 273-6291

Check out my books: Buying Established Business Assets: A Guide for Owners, https://www.amazon.com/dp/B09TJQ5CL5

and Advisors and Selling Established Business Assets: A Guide for Owners and Advisors, https://www.amazon.com/dp/B0BPTLZNRM

Legal Disclaimer

The blogs on this website are provided as a resource for general information for the public. The information on these web pages is not intended to serve as legal advice or as a guarantee, warranty or prediction regarding the outcome of any particular legal matter. The information on these web pages is subject to change at any time and may be incomplete and/or may contain errors. You should not rely on these pages without first consulting a qualified attorney.

Posted in problems with earnouts, robust objective buyer earnout covenants Tagged with: , , , , , , , , ,

Secure the Buyer’s Infrastructure Commitment or Risk Losing Your Earn-Out

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One Question Diagnostic: If your earn-out hinges on the buyer providing specific tools, staff, or technology, have you turned those promises into a mandatory contract requirement, or are you hoping their business interests will stay aligned with yours?

M&A Stories

December 30, 2025

Many business owners selling their companies see an earn-out as a bridge to a higher valuation. The logic is often centered on what the buyer brings to the table. You might believe that because the buyer has a world-class IT department, a massive warehouse, or a proprietary software platform, your business will naturally thrive under their wing. This expectation of support is often the very reason a seller agrees to a lower guaranteed price at closing in exchange for a larger payout later.

The deal in this case involved a target company that acted as a high-tech “brain” for bank trust departments. They provided the specialized software that helped banks manage complex investment rules and client reporting. The buyer was a massive financial giant that acted as a “vault.” While the target provided the software to manage the assets, the buyer had the massive infrastructure required to actually hold, move, and protect those assets—a service known as custody.

The plan was to combine the target’s “brain” with the buyer’s “vault.” By plugging the target’s software directly into the buyer’s asset-holding system, the combined company could offer a complete, one-stop shop. The target would bring the specialized client relationships and management software, and the buyer would bring the heavy-duty machinery to hold the money. This integration was the engine that was supposed to drive the revenue needed for the seller group (consisting of the target parent and key target management) to hit their fifteen-million-dollar earn-out.

The seller group was so convinced by this strategy that they rejected a competing offer from a different bidder. That rejected offer actually had a higher upfront cash payment and a potentially higher total price. However, the seller group chose this buyer because they believed the buyer’s unique “vault” services were the key to a successful future.

In a recent legal battle in the Delaware Court of Chancery, the seller group learned that relying on the buyer’s verbal promises about their infrastructure was a gamble that rarely pays off in court. During the sale process, the buyer’s team spoke at length about how their technology would integrate with the target’s business. They suggested that the technical work was minor and would be a priority.

Once the deal closed, the situation changed completely. The buyer decided the technical integration was too expensive and simply chose not to do it. Without that promised technology, the business could not grow as planned, and the seller group missed their performance targets. The seller group tried to argue that even if it was not in the contract, the buyer had a good faith obligation to make the technical changes so the sellers could reach their goals.

The court rejected this argument. It ruled that the good faith concept is only for filling unexpected gaps in a contract. Since the seller group and buyer had actually talked about the technology before closing but did not bother to put it in the final contract, there was no gap to fill. The court will not use a good faith argument to give a seller a protection they were too timid or too distracted to ask for in writing.

When the seller group sued, claiming they were misled, the court also pointed to a standard clause in the contract where the target’s owner had agreed it was not relying on any promises made outside of the written document. Because the contract did not specifically command the buyer to provide the technology, the buyer had no legal obligation to help the target owner reach its earn-out.

The takeaway is clear: A buyer’s business logic is not a legal substitute for a written covenant. This is true whether you are selling your stock, your assets, or merging your company. A buyer may have a logical reason to support your growth, but their internal priorities can shift overnight. They might experience a budget cut, a change in leadership, or a shift in corporate strategy that makes supporting your specific department a low priority. If your contract remains silent on what the buyer must provide, you have no recourse when they pull the rug out from under you.

To manage this risk before you sign the final papers, you must identify every piece of infrastructure that is vital to your post-closing success. This might include a guaranteed number of leads from their sales team, access to their distribution network, or a specific timeline for technical upgrades. These should be drafted as affirmative obligations, meaning the buyer is legally required to provide them regardless of whether they still think it is a good idea six months later.

By making these infrastructure needs a formal part of the agreement, you move the risk of integration back onto the buyer. If they fail to provide the tools they promised, you can argue that they breached the contract, which protects your right to the earn-out even if the targets are not met. Without these written commitments, you are essentially giving the buyer a way to walk away from the earn-out for free.

Civil Action No. 8490-VCG, Court of Chancery of Delaware (February 3, 2014)

Thank you for reading this blog. If you have any questions, insights, or if you’d like to engage in a more detailed discussion on this matter, I invite you to reach out directly.

Feel free to send me an email. I value thoughtful discussions and am always open to connecting with business owners, management, as well as professionals who share an interest in the complexities of M&A law in lower middle market private target deals.

By John McCauley: I write about recent problems of buyers and sellers in lower middle market private target deals.

Email: jmccauley@mk-law.com

Profile: http://www.martindale.com/John-B-McCauley/176725-lawyer.htm

Telephone:      714 273-6291

Check out my books: Buying Established Business Assets: A Guide for Owners, https://www.amazon.com/dp/B09TJQ5CL5

and Advisors and Selling Established Business Assets: A Guide for Owners and Advisors, https://www.amazon.com/dp/B0BPTLZNRM

Legal Disclaimer

The blogs on this website are provided as a resource for general information for the public. The information on these web pages is not intended to serve as legal advice or as a guarantee, warranty or prediction regarding the outcome of any particular legal matter. The information on these web pages is subject to change at any time and may be incomplete and/or may contain errors. You should not rely on these pages without first consulting a qualified attorney.

Posted in problems with earnouts, Put buy infrastructure promises in writing Tagged with: , , , , , , , , , , , , , , , , ,

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