Structuring Earn-Outs in South Carolina M&A: How to Bridge the Valuation Gap in Business Sales

During lower-middle-market business acquisitions across Charleston's Silicon Harbor technology corridor, the I-85 manufacturing belt in Greenville and Spartanburg, and industrial logistics hubs in Columbia, deals frequently stall over a fundamental disagreement on valuation. The founder demands a purchase price based on next year's projected pipeline and recent capital investments, while the private equity group or strategic buyer insists on paying a conservative multiple of trailing 12-month cash flow.

To prevent the transaction from collapsing, M&A attorneys structure an earn-out provision-a contingent pricing mechanism where the buyer pays 65% to 85% of the purchase price in cash at closing and commits to paying the remaining 15% to 35% over a 12-to-36-month post-closing measurement period if the business achieves specific financial or operational milestones. However, because an earn-out converts a present disagreement over value into a future test of post-closing accounting and operational control, poorly drafted earn-out clauses are the single most litigated provision in South Carolina M&A transactions.

Defining Financial Metrics: Top-Line Revenue vs. EBITDA in Definitive Agreements

In South Carolina contract law, courts do not rewrite poorly drafted commercial agreements to rescue a party from a bad bargain. In the landmark precedent C.A.N. Enterprises, Inc. v. South Carolina Health and Human Services Finance Commission, 296 S.C. 373 (SC Supreme Court 1988), the Supreme Court of South Carolina held that when construing a contract, the court's duty is strictly limited to interpreting the unambiguous language chosen by the parties themselves, regardless of its wisdom or folly or the failure of a party to guard its interests carefully. Furthermore, in Bluffton Towne Center, LLC v. Gilleland-Prince, 412 S.C. 554 (SC App. 2015), the court emphasized that all provisions dealing with the same subject matter must be read together to give effect to every defined term.

Consequently, simply stating in an Asset Purchase Agreement (S.C. Code Ann. § 33-12-102) or Merger Agreement (S.C. Code Ann. § 33-11-101) that an earn-out will be calculated in accordance with Generally Accepted Accounting Principles (GAAP) is a recipe for litigation. GAAP permits wide discretion in revenue recognition, inventory reserves, and expense capitalization. Sellers typically push for top-line gross revenue metrics because revenue is harder for a buyer to manipulate, whereas buyers insist on EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) or gross margin metrics to ensure the seller does not chase unprofitable, low-margin contracts just to hit a revenue target.

Industry-Specific Earn-Out Structures and Post-Closing Good Faith Mechanics

Tailoring the earn-out formula to the target company's specific revenue drivers prevents post-closing accounting ambushes.

Tech and SaaS Companies Relying on ARR and Subscription Renewals

When acquiring a software-as-a-service (SaaS) or managed IT provider in Charleston, Columbia, or Fort Mill, buyers frequently tie 20% to 40% of the purchase price to Annual Recurring Revenue (ARR), Net Dollar Retention, or multi-year enterprise subscription renewals. A major dispute arises under ASC 606 revenue recognition rules when a customer signs a 36-month subscription contract during the final quarter of the earn-out period, or when the buyer integrates the seller's software module into the buyer's larger enterprise suite.

To protect a tech founder, the definitive agreement must distinguish between Booked ARR (credited upon execution of a binding customer contract) and Recognized GAAP Revenue (amortized monthly over the contract term). Furthermore, if the buyer offers discounts on the target's software to cross-sell the buyer's legacy products, the earn-out schedule must impute credit to the seller's earn-out ledger at the software's pre-closing standalone selling price.

Logistics and Freight Companies Retaining Major Shipping Accounts

Acquisitions of trucking fleets, freight brokerages, and third-party logistics (3PL) warehouses serving the Port of Charleston and the Inland Port Greer/Dillon corridors frequently suffer from customer concentration-where two or three major automotive, tire, or retail shippers generate 50% of gross revenue. Buyers routinely demand an account-retention earn-out that pays out only if those anchor shipping accounts maintain baseline volume over the 18 to 24 months following closing.

The hidden trap for logistics sellers occurs when the buyer's parent logistics network shifts freight lanes, tractors, or warehouse capacity from the acquired South Carolina subsidiary to another division owned by the buyer, or raises freight rates so aggressively that the anchor customer leaves. Sellers must insert an Affiliate Diversion Clause stipulating that any revenue or tonnage generated from the seller's historical shipping customers by any entity affiliated with the buyer counts 100% toward the earn-out target.

Ensuring the Buyer Operates in Good Faith Post-Closing Under South Carolina Law

Once the deal closes, the buyer owns the business and controls its budget, pricing, and personnel. Sellers often assume that if the buyer makes post-closing changes that depress earnings, South Carolina's implied covenant of good faith and fair dealing will automatically rescue their earn-out. Relying on implied good faith alone is a dangerous mistake.

In Commercial Credit Corp. v. Nelson Motors, Inc., 247 S.C. 360 (SC Supreme Court 1966), the Supreme Court of South Carolina established that every contract contains an implied covenant of good faith and fair dealing requiring a party vested with contractual discretion to exercise that discretion reasonably. However, in the pivotal decision Adams v. G.J. Creel and Sons, Inc., 320 S.C. 274 (SC Supreme Court 1995), the Supreme Court of South Carolina ruled that there is no breach of the implied covenant of good faith and fair dealing where a party has done what the express provisions of the contract gave it the right to do. Because buyers routinely insert boilerplate language stating that the buyer shall have sole and absolute discretion over all post-closing business operations, an express sole-discretion clause can completely neutralize an implied good faith claim under Adams v. G.J. Creel and Sons, Inc., 320 S.C. 274 (SC Supreme Court 1995).

To legally bind the buyer in South Carolina, sellers must negotiate express post-closing operational covenants inside the Purchase Agreement:

• Separate Books and Records Covenant: Requiring the buyer to maintain the acquired business as a standalone accounting unit (or separate P&L ledger) throughout the earn-out period.
• Consistent Historical Operations Covenant: Requiring the buyer to operate the business in the ordinary course consistent with past practices, maintaining historical working capital, marketing spend, and sales staff headcount.
• Anti-Diversion and Anti-Frustration Covenant: Expressly prohibiting the buyer from taking any action with the primary purpose or foreseeable effect of reducing the earn-out payment.
• Full Acceleration Triggers: Providing that the maximum 100% earn-out becomes immediately due and payable in full if the buyer sells the subsidiary to a third party, terminates the seller's post-closing executive employment without cause, or breaches a material operational covenant.

Step-by-Step Process for Drafting and Enforcing an Earn-Out in South Carolina

Protecting contingent purchase price payments in South Carolina transactions follows six essential steps.

Step 1: Structure Sliding-Scale Targets Instead of All-or-Nothing Cliffs

During the Letter of Intent stage, avoid binary cliff thresholds (where achieving 99.5% of an $8,000,000 EBITDA target yields $0). Instead, negotiate a linear sliding scale (such as pro-rata payouts starting at 80% of the target) coupled with a multi-year catch-up or carry-forward provision so a strong Year 2 cures a temporary supply-chain dip in Year 1.

Step 2: Attach a Bespoke Accounting Schedule and Sample Calculation

Rather than relying on generic GAAP, M&A counsel and transaction CPAs attach a binding Accounting Methodology Schedule to the Purchase Agreement containing a line-by-line mock calculation based on the seller's historical financial statements, establishing that historical accounting practices trump general GAAP in the event of a conflict.

Step 3: Separate Purchase Price from Compensation for Tax Compliance

To ensure the seller's earn-out payments are taxed at favorable federal long-term capital gains rates under the installment method (26 U.S.C. § 453) rather than ordinary wage income-and to prevent employment-law recharacterization disputes under the South Carolina Payment of Wages Act (S.C. Code Ann. § 41-10-10(2))-never condition the earn-out payout on the seller's continued employment. Properly report the transaction structure using Form 8594, Federal, Internal Revenue Service, Asset Acquisition Statement Under Section 1060 and Form 6252, Federal, Internal Revenue Service, Installment Sale Income, accounting for imputed interest under 26 U.S.C. § 483.

Step 4: Audit the Buyer's Earn-Out Statement and Issue a Timely Objection Notice

Within 45 to 60 days after each annual measurement period ends, the buyer must deliver a certified Earn-Out Calculation Statement along with full general ledger access. The seller then has a strict contractual window (typically 30 to 45 days) to audit the books and deliver a written Notice of Disagreement itemizing disputed overhead charges or deferred revenues.

Step 5: Resolve Accounting Disputes Through Independent CPA Arbitration

Most South Carolina M&A agreements bifurcate dispute resolution: pure mathematical and accounting classification disputes are referred to an independent nationally recognized accounting firm acting as an expert or arbitrator under the South Carolina Uniform Arbitration Act (S.C. Code Ann. § 15-48-10), whose determination is binding within 30 to 60 days.

Step 6: Litigate Operational Bad-Faith Breaches in the South Carolina Business Court

If the buyer breached operational covenants, diverted customers, or acted in bad faith-issues that an accounting referee lacks authority to decide-the seller must file a civil breach of contract lawsuit within South Carolina's 3-year statute of limitations (S.C. Code Ann. § 15-3-530(1)) using Form SCCA 234, South Carolina, Judicial Department, Civil Action Coversheet. Complex M&A earn-out lawsuits are routinely assigned to specialized Business Court judges via Form SCCA BC 101, South Carolina, Judicial Department, Motion and Order for Case Assignment to the Business Court Program in the Charleston County Court of Common Pleas, Business Court Program, Charleston, the Greenville County Court of Common Pleas, Business Court Program, Greenville, or the Richland County Court of Common Pleas, Business Court Program, Columbia, or litigated in the U.S. District Court for the District of South Carolina, Charleston.

How Much Does It Cost to Structure or Litigate an Earn-Out in South Carolina?

Both buyers and sellers should account for the legal and forensic accounting costs associated with earn-out structures:

• M&A Transactional Drafting & CPA Modeling Fees: Drafting a customized earn-out provision, negotiation of post-closing operational covenants, and CPA modeling of the bespoke EBITDA/revenue schedule typically adds $5,000 to $15,000 to overall M&A transaction legal and accounting fees.
• Post-Closing Independent CPA Arbitration Costs: Engaging a neutral third-party accounting firm to resolve a disputed annual earn-out calculation typically costs between $15,000 and $45,000, which the Purchase Agreement usually allocates inversely based on the percentage of the disputed amount awarded to each party.
• South Carolina Business Court & Federal Filing Fees: Filing a civil breach-of-contract action in a South Carolina Court of Common Pleas costs $150.00 (plus a $25.00 motion fee when moving for Business Court assignment), while filing a diversity action in the U.S. District Court for the District of South Carolina costs $405.00.
• Commercial Litigation Attorney Fees: Litigating a multi-million-dollar bad-faith earn-out lawsuit through discovery, forensic accounting depositions, and trial generally costs $50,000 to $200,000+, though many M&A agreements include a prevailing-party fee-shifting clause that forces the losing party to pay the winner's reasonable attorney fees.

How Long Do Earn-Out Periods and Post-Closing Disputes Take?

In South Carolina lower-middle-market M&A transactions, earn-out measurement periods typically span 12 to 36 months following the closing date. After each annual period closes, the buyer generally has 45 to 60 days to deliver the earn-out statement, followed by a 30-to-45-day review and objection window for the seller. If an accounting dispute is sent to an independent CPA arbitrator, resolution typically takes 60 to 90 days; if a bad-faith operational breach is litigated in the South Carolina Business Court Program, reaching summary judgment or trial generally takes 12 to 20 months. To structure an ironclad earn-out or enforce an unpaid M&A milestone, browse our directory of experienced South Carolina corporate M&A and business litigation attorneys today.

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