Reducing earn-out disputes: seven points to settle in the SPA

The formula starts with the right metric

An earn-out can be tied to EBITDA, revenue or a defined operational milestone. EBITDA can track profitability but imports accounting judgements and allocation questions. Revenue is more readily measured but may not reflect margin or cash generation, while a milestone can suit a regulated product, contract award or development programme where financial performance is not yet the right measure.

The metric should state the accounting policy hierarchy in terms that leave no room for inversion: first, the specific policies agreed in the SPA; secondly, the target's historic policies applied consistently; and thirdly, the applicable reporting framework. The hierarchy needs to address cash, debt, revenue recognition, provisions, capitalisation, exceptional items and the treatment of acquisition-related costs. A general reference to accounts prepared fairly and consistently does not do the same work.

A simple example illustrates the point. If the target historically expensed software development costs, an earn-out calculation should continue that treatment unless the SPA specifically provides that the costs will be capitalised. Moving directly to the applicable reporting framework could produce a different EBITDA figure and therefore a different deferred price, even where the underlying business has not changed.

Deferred consideration also has a tax treatment that should be established during structuring rather than after completion. The SPA should identify the payment obligation, timing and any withholding or gross-up mechanics, while the parties take tax advice on how the consideration is characterised. The tax position does not change the agreed metric, but it can change the economics of a proposed structure.

Control after completion needs defined boundaries

The recurrent issue is not whether the formula can be calculated but whether the buyer was required to operate the business so that the target could be achieved. Dutch law may supplement the agreement through standards of reasonableness and fairness, but those standards do not provide a detailed operating plan for an integrated group. The parties should decide the operational balance rather than leave it to later interpretation.

Case law on earn-outs underlines the importance of the parties' express allocation of operational freedom and of the factual context in which the earn-out was agreed. It does not support a general rule that a buyer is always obliged, or never obliged, to run the business for the seller's benefit.

An SPA can preserve the buyer's freedom to integrate, finance and manage the business, subject to a short list of reserved matters during the earn-out period. Those matters may include disposal of a material asset, closure of a site, transfer of the relevant activity, a material change to the budget or a change to reporting lines. The list should be tailored to the metric, because a revenue earn-out and a milestone earn-out call for different protections.

Investment, capital expenditure and headcount require the same precision. A reference to ordinary-course management may be insufficient where an integration plan contemplates shared systems, new sales staff or centralised functions. A stated annual budget, a baseline headcount and a process for deviations give the buyer operating room and give the seller a defined reference point.

Costs, information and a defined remedy

Post-completion integration creates questions about group overhead, management charges and shared costs. The SPA should state which costs are borne by the target for earn-out purposes, how shared services are allocated and whether new charges are excluded, capped or tested against an arm's-length methodology. It should also address intercompany revenue and cost allocation, since the same commercial activity may otherwise move between entities without a clear consequence for the metric.

Information rights make an earn-out auditable while the period is still running. Monthly or quarterly reporting, access to the calculation workpapers, management accounts and reasonable access to relevant personnel can be agreed without transferring management control. The seller's audit right needs a notice period, confidentiality protections, a defined advisor category and a clear limit on disruption.

A bare good-faith obligation does not resolve the question of manipulation. A more workable covenant identifies prohibited conduct, such as diverting revenue, allocating unusual costs or taking steps principally intended to reduce the earn-out, and identifies the consequence. The remedy may be recalculation on an agreed counterfactual basis, damages, or expert determination of the relevant adjustment.

Art. 6:23 DCC can be relevant where a party prevents fulfilment of a condition, but the provision is not a substitute for a transaction-specific covenant and remedy. The SPA should establish whether the covenant applies to an act, an omission or a decision made across the buyer's group. It should also preserve legitimate business reasons for a decision, with the agreed metric and period as the reference point.

Expert determination closes the calculation route

An earn-out determination provision is a contractual process, not an afterthought. The parties can frame the accountant's appointment, mandate, timetable, submissions, access to records, cost allocation and the finality of the determination. Depending on its terms, the arrangement can be structured as binding advice within the framework of art. 7:900 et seq. DCC.

The mandate should limit the expert to disputed calculation issues rather than asking for a general judgement on the transaction. It should state whether the expert chooses between the parties' positions or reaches an independent calculation. Under art. 7:904 DCC, a binding determination can be set aside only in limited circumstances, which makes clarity on scope and finality especially valuable.

The seven points are therefore connected: the metric, accounting hierarchy, operational freedom, investment baseline, cost allocation, information rights and anti-manipulation remedy all inform the final determination. A clause that settles them at signing provides a workable route through an earn-out period that may otherwise be governed by broad principles and incomplete records.