The earnout is the most-litigated provision in agency purchase agreements because it bridges a valuation gap on future performance, and future performance is exactly what two parties can disagree about. The metric choice sets the tone: retention is the gold standard for book deals, while EBITDA usage has fallen to 17% of deals because it's a derived rather than observed number, and the clause has to define every step of the derivation. The retention formula is clean — commission earned on the baseline client list in the 12 months preceding the measurement date, divided by the baseline commission, equals the retention percentage — and only baseline-list clients count, which protects both sides from arguments about new business.
§ 01 · Cliff vs. sliding scaleThe structure choice.
| Structure | How it pays |
|---|---|
| Cliff | Full payment at a threshold (e.g., 85% retention), zero below — a binary outcome |
| Sliding scale | Proportional between floor and ceiling — 75% pays 50%, 85% pays 100%, linear between |
The sliding scale is the modern preference because it avoids the cliff effect, where a single lost client flips a $450K earnout to zero. The term runs one to three years, with 12 months the most common — a longer term keeps the seller engaged but introduces operational friction and dispute risk. The earnout-vs-holdback distinction is worth keeping straight: an earnout bridges a valuation gap on future performance (20–30% of price, high seller visibility, high drafting complexity), while a holdback retains funds against post-close indemnity claims (10–15%, low seller visibility, moderate complexity). Buyers who conflate the two produce disputes that neither document resolves.
§ 02 · The conduct covenantsSix buyer, four seller.
Because the buyer controls the book during the measurement period, six buyer conduct covenants protect the seller's earnout: operate the book in the ordinary course consistent with pre-close practice; no commission-rate or schedule reduction; no account reallocation to other producers, offices, or entities; quarterly or monthly financial reporting to the seller; no material change to the service model, management system, or carrier relationships without notice; and no new corporate overhead allocated against the book. Four seller covenants run the other way: cooperate with client transition and introductions, no solicitation of baseline-list clients, honor the non-compete, and provide reasonable consulting support during the measurement period. The covenants are what keep the buyer from engineering the metric down and the seller from engineering it up.
§ 03 · Specific drafting winsThe good-faith trap.
An implied good-faith duty is insufficient. Courts will read in whatever good-faith obligations the clause fails to specify — and the precedents make clear that specific drafting wins. The earnout that survives is the one that defines the metric, the data source, the covenants, and the dispute path explicitly, rather than relying on the parties to cooperate in good faith after the incentives have diverged.
Bifurcated dispute resolution is the structural answer to the litigation risk. Calculation disputes go to an independent accountant for a 30-day binding determination, with fees split equally unless one party's position is entirely rejected. Breach disputes go to arbitration with normal timelines and discovery. The bifurcation prevents a calculation disagreement from halting business operations — the most common way an earnout dispute spirals. Payment mechanics need the same specificity: the form (cash, wire, or set-off against seller-note principal), the timing (30–60 days after measurement), a review-and-objection window (buyer delivers the calculation, seller has 30 days to object, unresolved items go to dispute resolution), interest on late payment, and offset rights against unpaid indemnity claims.
§ 04 · The drafting checklistTen items, one survival rule.
A complete earnout clause covers ten items: the metric, the data source, the measurement and payment dates, the baseline client-list schedule, the cliff or sliding-scale anchors, the mutual conduct covenants, a management-system migration restriction, shadow accounting, bifurcated dispute resolution, and the payment mechanics. The eleventh discipline is a survival rule that's easy to miss: the earnout must survive past the general representations-and-warranties survival periods, because an earnout is not extinguished by general R&W survival and a clause that lets it lapse with the reps defeats its own purpose. Draft all of that explicitly and the earnout does what it's meant to — bridge the valuation gap — instead of becoming the dispute that swallows the deal.
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Terminology on this shelf
- Retention metric
- Baseline-list commission over a 12-month window divided by baseline commission — the gold-standard earnout measure.
- Cliff vs. sliding scale
- Binary payment at a threshold versus proportional payment between floor and ceiling — sliding scale is preferred.
- Conduct covenants
- The six buyer and four seller promises governing the measurement period — they keep the metric honest.
- Bifurcated dispute resolution
- Calculation disputes to an accountant, breach disputes to arbitration — prevents calculation fights halting operations.
- Earnout vs. holdback
- Future-performance bridge (20–30%) versus indemnity reserve (10–15%) — distinct documents, distinct purposes.
- Survival past R&W
- The rule that an earnout outlives the general rep survival periods — easy to miss, fatal to omit.