How to Structure an Earn-Out Agreement in a Wisconsin M&A Deal to Avoid Post-Closing Disputes

When buying or selling a business in Wisconsin, both parties rarely agree on the exact value of the company. A seller often believes the business will grow rapidly, while a cautious buyer worries about future risks. An earn-out agreement solves this problem by allowing the buyer to pay a portion of the purchase price later, but only if the business hits specific financial targets. However, earn-outs are notorious for causing bitter legal battles after the deal closes. If the contract is vague, a buyer might manipulate accounting practices to avoid paying the seller. Structuring these provisions carefully under Wisconsin law ensures both sides get a fair deal.

Avoiding Post-Closing Disputes and Intentional Suppression

The most common cause of an earn-out dispute is when the seller accuses the buyer of intentionally tanking the business or changing accounting rules to miss the financial targets. In Wisconsin, every contract carries an implied duty of good faith and fair dealing, as demonstrated in cases like Foseid v. State Bank of Cross Plains, 197 Wis. 2d 772 (WI Court of Appeals 1995). This means a buyer cannot actively sabotage the business just to avoid paying the earn-out. To prevent litigation in courts like the Dane County Circuit Court, Madison, the purchase agreement must explicitly state that the buyer will operate the business in the ordinary course and use the same Generally Accepted Accounting Principles (GAAP) that the seller used before the sale.

Structuring Earn-Out Provisions by Industry

Revenue-Based Earn-Outs for Tech Firms

For software and technology companies in cities like Madison and Milwaukee, growth is usually measured by top-line revenue rather than immediate profit. Revenue-based earn-outs are generally safer for sellers because revenue is harder for a buyer to manipulate than net income. The agreement should clearly define what counts as "recognized revenue" and exclude any inter-company transfers or new product lines that the buyer introduces after closing, ensuring the seller is judged strictly on the performance of the core tech product.

EBITDA Targets for Manufacturing

Wisconsin has a massive manufacturing sector. In these deals, buyers usually tie earn-outs to EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization). This measures the true operational cash flow of the factory. However, EBITDA is highly susceptible to accounting manipulation. Sellers must aggressively negotiate to exclude post-closing "management fees" or corporate overhead that the new buyer might try to charge to the business, which would artificially lower the EBITDA and wipe out the seller's earn-out payment.

Milestone-Based Payouts in Pharma

For biotechnology and pharmaceutical companies, financial targets are less relevant than clinical progress. In these deals, the earn-out is typically structured around specific operational milestones. For example, the seller receives a specific payout if the company successfully achieves FDA Phase II trial approval by a specific date, or when a new patent is officially granted. These milestones must be written with absolute clarity so there is zero debate about whether the condition was met.

Step-by-Step Guide to Structuring the Agreement

Drafting an ironclad M&A agreement requires precision. You can easily find an experienced corporate attorney in our US Lawyers directory to help you negotiate these exact terms.

Step 1: Define the Financial Metrics Clearly

Do not use vague terms like "net profit." Your contract must include a detailed appendix outlining exactly how the financial target will be calculated. Specify that the buyer must use consistent accounting methods. If the buyer normally uses a different accounting standard, clearly state how the transition will be handled during the earn-out period.

Step 2: Establish Operational Control Covenants

Sellers must demand "protective covenants." These are rules the buyer must follow during the earn-out period. For example, the buyer must agree to provide adequate working capital, retain key employees, and not divert critical sales leads to the buyer's other subsidiary companies. If the buyer breaches these covenants, the agreement should state that the earn-out becomes immediately payable in full.

Step 3: Draft Dispute Resolution Clauses

Always include a mandatory dispute resolution process. If the buyer and seller disagree on the final earn-out calculation, the contract should require them to hire an independent, mutually agreed-upon accounting firm in Wisconsin to review the books. The decision of this independent accountant should be final and binding, keeping the dispute out of the Milwaukee County Circuit Court, Milwaukee and saving both parties years of expensive litigation.

Costs and Timelines for M&A Agreements

Corporate attorneys generally charge hourly rates ranging from $300 to $650 per hour depending on their experience in complex M&A transactions. Negotiating and drafting a comprehensive Asset Purchase Agreement or Stock Purchase Agreement with custom earn-out schedules usually takes between 30 and 90 days. While legal fees can range from $15,000 to $50,000 or more, investing in an airtight contract prevents multi-million dollar lawsuits down the road.

Revenue vs. EBITDA Earn-Outs

Frequently Asked Questions (FAQ)