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Earn-out: How to set KPIs and control rules to avoid disputes

What is an earn-out? An earn-out is a purchase price adjustment mechanism used in M&A transactions, where part of the seller’s consideration is paid only after closing, provided the target company achieves agreed performance targets (KPIs) within a defined period. In practice, an earn-out helps bridge valuation gaps between buyer and seller, but it also creates room for disputes about how results were calculated and whether the buyer influenced performance through post-acquisition management decisions.

Why earn-out disputes are common

An earn-out works well only when the parties precisely agree on definitions, data sources, and control rules. Otherwise, the dispute typically isn’t about the concept itself, but about measurement methodology and the impact of business decisions on the outcome. The most common issues include:

• ambiguous KPIs or missing definitions of key accounting and operational terms,
• post-acquisition changes to accounting policies that shift results between periods,
• disagreements over whether specific costs or revenues are “one-off” or “ordinary course,”
• limited access for the seller to data (a common problem: post-closing performance monitoring),
• conflicts of interest when the buyer optimizes its wider group in parallel.

How to set earn-out KPIs: principles for designing metrics

Designing KPIs should start with one question: what is the earn-out meant to measure—growth, maintaining profitability, or delivering a commercial plan? Good KPIs are measurable, verifiable, and resistant to “creative” interpretation. In practice, consider:

Financial KPIs: EBITDA, revenue, cash flow

The most common earn-out KPIs are EBITDA, revenue, or net profit. Each comes with different risks:

• EBITDA can be affected by cost classification, accruals/deferrals, and provisioning policies.
• Revenue may be sensitive to revenue recognition rules, discounts, returns, and intragroup transactions.
• Cash flow limits “accounting” manipulation, but depends on working capital policy and investment decisions.

It is crucial to specify whether KPIs are calculated at the level of the company, a segment, a project, or the whole group—and whether they include transactions with related parties.

Operational KPIs: volume, margin, customer metrics, churn

In some industries, operational KPIs (e.g., number of active customers, sales volume, churn, product margin) work better. They provide greater control over methodology, but require agreement on data sources (CRM, billing systems) and data “cleaning” rules.

One methodology for the entire earn-out period

One of the most common mistakes is failing to include clauses that ensure consistent calculation methods over time. The SPA should state that KPIs will be calculated using the same accounting and reporting principles in effect as of closing—unless a change is required by law, in which case its impact should be neutralized in the calculation.

Earn-out period and schedule: how to reduce “result shifting” risk

The earn-out period should reflect the business cycle and the time it takes for post-acquisition actions to realistically affect performance. Too short a period increases the temptation to “boost” results at the expense of quality; too long a period makes it difficult to attribute outcomes to pre-acquisition value drivers.

In practice, the following often help:

• annual settlements with quarterly reporting,
• minimum and maximum thresholds (floor/cap),
• partial payments for achieving successive KPI thresholds.

Earn-out payment terms: definitions, exclusions, and adjustments

Disputes often arise because the parties didn’t agree on what exactly goes into the calculation. Earn-out payment terms should include at least:

• a KPI definition together with the calculation formula,
• data sources and the reporting format,
• a list of adjustments (e.g., one-off items, restructuring costs),
• rules for treating related-party transactions,
• reporting and payment deadlines, and default interest for late payment.

Earn-out and post-acquisition management: buyer discretion and covenants

The most conflict-prone area is earn-out and post-acquisition management. The buyer typically wants full flexibility to integrate and run the business, while the seller needs protection against actions that could depress KPIs.

In SPAs, two approaches are common:

• “Good faith” / “commercially reasonable efforts” standard—the buyer undertakes not to take actions aimed at reducing the earn-out and to act in a commercially reasonable manner. This needs clarification because it is inherently subjective.
• Hard operational undertakings—a list of actions requiring the seller’s consent or prohibited during the earn-out period (e.g., transferring key contracts, changing discount policy, material capex).

A middle-ground solution is a “reserved matters” list and a consultation obligation for decisions that may materially impact KPIs—without fully paralyzing management.

Post-closing performance monitoring: audit rights, data access, and dispute resolution

Without real verification tools, an earn-out can quickly become a source of escalation. The SPA should provide for:

• the seller’s right to receive periodic KPI reports in an agreed structure,
• access to underlying records within reasonable limits (e.g., general ledger/GL, sales registers, contracts),
• the right to an audit by an independent statutory auditor or audit firm,
• a dispute resolution procedure with deadlines to raise objections and for the buyer to respond,
• resolution by expert determination rather than court litigation where the dispute concerns calculation/accounting only.

This is where well-drafted earn-out clauses in an SPA can materially reduce the risk of months-long conflict and payment deadlock.

Earn-out security for the seller: how to improve enforceability

If a significant portion of the price depends on future performance, the seller will typically expect tools that increase payment certainty. Earn-out security for the seller may include:

• an escrow to secure potential earn-out amounts (less common, but possible where the seller has strong leverage),
• a bank guarantee or a parent company guarantee,
• set-off rights only in strictly defined situations,
• contractual default interest and enforcement costs in case of delay,
• acceleration clauses if the company is sold onward or materially reorganized.

Most common earn-out disputes: a checklist to review before signing the SPA

1. Do the KPIs have a clear definition and formula, and are key accounting terms specified?
2. Are the accounting policies and the treatment of extraordinary/non-recurring items described?
3. Is the impact of intragroup transactions and HQ cost allocations defined?
4. Does the seller have meaningful information and audit rights?
5. Is the dispute resolution mechanism fast and fit for purpose (expert vs court)?
6. Are the earn-out period management provisions compatible with the buyer’s integration plan?

This material is for information purposes only and does not constitute legal advice. For matters requiring tailored KPIs, reporting rules, and SPA wording aligned with a specific business model, support may be provided by Kopeć & Zaborowski (KKZ). If you need an analysis of earn-out provisions and transaction risks, please contact us.

FAQ: Earn-out—how to set KPIs and control rules to avoid disputes?

1) What is an earn-out and when does it make sense in a transaction?

An earn-out is a deferred portion of the purchase price that depends on post-closing performance. It makes sense where there is a valuation gap driven by uncertainty about future revenue, customer retention, or strategy execution.

2) How should earn-out KPIs be set to ensure they are verifiable?

KPIs should include definitions, a calculation formula, and clear data sources. It is also worth adding consistency-of-methodology rules and a list of adjustments to reduce discretion in the outcome.

3) How long should the earn-out period be?

It depends on the industry and sales cycle. A 12–36 month period is common, with quarterly reporting and annual settlement. The period should be long enough to reveal sustainable effects, but not so long that KPIs stop reflecting the “value being acquired.”

4) What do earn-out payment terms typically cover in practice?

Payment terms typically include: KPI definitions, reporting deadlines, an objections process, payment deadlines, adjustment rules, and any security (e.g., a guarantee, escrow).

5) What does post-closing performance monitoring look like in an earn-out?

It is a set of seller rights to receive reports, review underlying documentation, and conduct an audit, along with a procedure to resolve disputes over the calculation.

6) How can you reduce the risk of conflict around earn-out and post-acquisition management?

Helpful tools include clauses defining the buyer’s standard of conduct (e.g., commercially reasonable efforts), a list of decisions requiring consultation or consent, and rules on cost allocation and intragroup transactions.

7) What are the most common earn-out disputes and how can they be prevented?

Most disputes concern KPI methodology, changes in accounting policies, and the impact of the buyer’s decisions. Prevention relies on precise definitions, stable methodology, audit rights, and a fast dispute resolution mechanism via an independent expert.

Bibliography

[1] Act of 23 April 1964 – Civil Code (consolidated text: Journal of Laws 2024, item 1061, as amended).

[2] Act of 15 September 2000 – Commercial Companies Code (consolidated text: Journal of Laws 2024, item 18, as amended).

[3] Act of 29 September 1994 on Accounting (consolidated text: Journal of Laws 2024, item 619, as amended).