Revenue or EBITDA: choosing the yardstick your earn-out is measured against

Revenue is the easiest number to measure and the weakest measure of value. EBITDA matches how your price was set and puts every add-back in play. Pick the highest line your buyer will accept, define it against a worksheet from your own books, and calendar the objection deadline at signing.

Which is safer for a seller: a revenue earn-out or an EBITDA earn-out?

A revenue earn-out is safer to measure than an EBITDA earn-out. Revenue sits at the top of the income statement, so almost no accounting judgment sits above it. EBITDA sits lines lower, with cost allocation, burden rates and add-backs in between. Judgment belongs to whoever keeps the books, and after closing that is the buyer.

Revenue has one weakness. Revenue can be bought. Discounts, longer terms, weak credit screening and unprofitable work all raise revenue and lower value. A buyer accepting a pure revenue metric will want something back.

A clean metric protects arithmetic, not conduct. In one Delaware case the buyer paid $40 million at closing and agreed to pay up to $40 million more on revenue targets. The agreement barred diverting or deferring revenue with intent to reduce the earn-out. Revenue fell short. Intent was not proven, and the implied covenant claim failed with it.

Case: Lazard Technology Partners, LLC v. QinetiQ North America Operations LLC, 114 A.3d 193 (Del. 2015).

How do the four common earn-out metrics actually compare?

The four metrics used in owner-operated deals are revenue, gross margin, EBITDA and net income. Each one trades measurement certainty against economic accuracy. Revenue is the most objective and the least tied to value. Net income sits nearest the buyer’s bottom line and is the most exposed to its overhead, borrowings and tax positions.

Can an earn-out use two metrics, or no financial metric at all?

Yes. Combined tests and non-financial milestones are both available. A combined test pays on revenue subject to a gross margin or EBITDA floor. A non-financial milestone pays on a discrete event that requires no accounting determination at all. Multiple metrics are common in larger private deals; in owner-operated sales, one metric is still the norm.

How a combined test is drafted decides everything. A test that requires you to clear revenue and earnings is two conditions and two chances to fail. A test that pays on revenue and then reduces the payment if margin falls below a floor is one condition with a haircut. Ask for the second version.

Non-financial milestones are the quiet win in a smaller deal. They are binary, cheap to prove and hard to recompute. Examples that work in owner-operated businesses:

• A named customer contract renewed for a stated term.
• A license, permit or certification reissued to the buyer’s entity.
• A stated number of your top twenty accounts still buying at year one.

Market data: ABA Private Target Mergers and Acquisitions Deal Points Study (2025), earn-out use at 18 percent of studied deals, down from 26 percent in 2023; SRS Acquiom 2025 M&A Deal Terms Study, 68 percent of studied earn-out deals using multiple metrics. Both cover deals far larger than yours; read them as direction, not norm.

Why is “determined in accordance with GAAP” not a real definition?

A reference to GAAP in the earn-out section is not a standard. It identifies which body of principles applies. It does not tell you which permitted treatment the buyer will choose, and it does not stop the buyer from conforming your company to its own accounting policies after closing. The definition has to name the treatments.

Delaware courts enforce the words you signed, not the accounting you assumed. A GAAP reference will not rescue you once the agreed calculation-and-objection process has run against you. The Delaware Supreme Court held a related line: a post-closing true-up serves a limited purpose and is not a vehicle for relitigating historical GAAP compliance.

Case: Chicago Bridge & Iron Co. N.V. v. Westinghouse Electric Co., 166 A.3d 912 (Del. 2017), a purchase price adjustment rather than an earn-out.

So write the definition. Tie the metric to your own prior accounting, identified by document and period, and attach a worksheet applying it to a real year. Then name these in the exhibit:

• Purchase accounting. Depreciation and amortization from the asset step-up and acquired intangibles are excluded.
• Acquisition and affiliate debt. Interest, fees and financing costs on deal or pushed-down debt excluded; affiliate interest excluded or rate-capped.
• Rent. If the buyer or an affiliate becomes your landlord, rent stays at the closing lease rate.
• Overhead and management fees. Excluded, or capped at a stated amount or percentage of revenue.
• Deal and integration costs. Transaction expenses and charges from buyer-initiated reorganization, headcount changes or systems conversion.
• The earn-out itself. Accruals, payments and fair value changes are excluded. Otherwise your payment reduces the number that generates it.
• Changes in policy. Any policy, estimate, reserve or capitalization threshold adopted after closing is disregarded.

A metric without a definition is not a price term. It is an agreement to argue later, on the buyer’s ledger.

How do I make sure the targets and the measurement use the same accounting?

Reconcile them on paper before signing. The target came from somewhere: an adjusted EBITDA schedule in a quality-of-earnings report, a broker’s recast, or add-backs you negotiated. Apply the earn-out definition to that same historical period. If the two numbers do not match, the definition is wrong.

This is the most valuable hour in the negotiation, and almost nobody spends it. Run the definition across last year line by line and put the number and schedule into the agreement as the base year exhibit. Every add-back the buyer accepted is then documented and harder to disallow. A target set on seller-adjusted EBITDA but measured on buyer-conformed EBITDA is two deals, and you signed the wrong one.

How should the earn-out periods and the payout scale be structured?

Use annual measurement periods, a sliding scale that starts paying below target, and a carryforward that lets a strong year cure a weak one. An all-or-nothing cliff converts one soft quarter into a total loss. Cumulative measurement and partial credit are the two structural protections that cost a buyer the least to give.

Ask for four things. A floor where payment begins, well below plan; 70 to 80 percent of target is a workable opening ask, not a market standard. Straight-line scaling to the maximum. A cumulative catch-up, so clearing the two-year target in year two recovers the year one shortfall. And an outside payment date, with interest if the buyer is late.

Keep the period short. Studies of larger private deals report shorter periods, none beyond four years recently, and smaller deals are shorter still. Two years is normally enough to prove the point you are asked to prove.

What happens if I miss the earn-out objection deadline?

If your agreement says so, and most do, the buyer’s calculation becomes final and binding once the objection period runs. Delaware courts enforce that framework. A missed written objection is not a stumble a court excuses because the accounting was wrong. Only fraud or a defective statement usually survives it.

So build the window deliberately. Six drafting points decide whether you can use it:

• Length and trigger. Buyers often offer thirty days. Ask for forty-five to sixty, running from your receipt of a complete statement.
• Contents. The calculation, supporting schedules and a reconciliation to the base year exhibit. Say expressly that an incomplete statement does not start the clock.
• Access. A stated right, during the window, to books, workpapers and the people who prepared the calculation.
• Particulars. Your notice must be written and specify each disputed item and your amount. A general denial risks being treated as no objection.
• Scope of the neutral. The accountant decides only disputed items, only within the range of the two positions, and only by applying the definition as written.
• Undisputed amounts. Anything not disputed is paid immediately, not held hostage to the dispute.

Watch the fourth and fifth points together. In February 2026 the Delaware Supreme Court held that a clause sending disputes over calculation of the earn-out amount to an accounting firm was an arbitration, not an expert determination. The buyer had declared no earn-out owed. The seller’s representative sued for bad faith manipulation of adjusted EBITDA. Those claims went to the firm, not the court.

Case: Fortis Advisors, LLC v. Stillfront Midco AB, No. 162, 2025 (Del. Feb. 13, 2026).

So decide in the agreement which disputes go where. Accounting disputes to the accountant. Bad faith, covenant breaches and failure to use agreed efforts to a court. Say it expressly.

Delaware courts do police buyer conduct when the words support it. In a March 2026 post-trial decision, the Court of Chancery found a buyer breached its purchase agreement by terminating key executives without cause and seizing operational control during the earn-out period, then reinstated an executive and extended the window. That seller had covenants to sue on, it took a trial, and those remedies are discretionary.

Case: Fortis Advisors, LLC v. Krafton, Inc. (Del. Ch. Mar. 16, 2026).

The objection deadline does not care whether the buyer’s math was right. It only cares what you sent, in writing, and when.

How does an earn-out change my taxes and the buyer’s financing?

An earn-out usually makes your sale a contingent payment sale for federal tax purposes, and it can disqualify a buyer’s SBA-backed acquisition loan. Both points are stated as of August 2026. Both change the metric conversation, because a payment you cannot receive on acceptable terms is not worth negotiating the accounting for.

On tax, the temporary regulation reports contingent payment sales on the installment method unless you elect out, and only for the portion of the sale eligible for installment reporting; inventory and depreciation recapture are taxed at closing regardless. With a stated maximum selling price, each payment splits between gain and basis on a gross profit ratio. With no maximum but a fixed payment period, basis spreads in equal annual increments over those years. A cap has a tax consequence as well as an economic one.

Law: 26 CFR 15a.453-1(c)(1) through (c)(3).

Ask your CPA three questions before agreeing to a metric. Whether to elect out of the installment method. How much of each payment is treated as interest. And whether tying payments to your continued employment changes the character of what you receive. Confirm your state’s treatment of installment gain and residency in the payment years too.

On financing, if your buyer is using an SBA 7(a) loan, raise the earn-out with the lender before you agree to it. SBA lenders treat contingent consideration that is really deferred purchase price as an amount to be funded at closing or papered as seller financing on full standby, and lender counsel guidance has long treated earn-outs as impermissible in SBA change-of-ownership deals. Ask which version of the procedures governs your buyer’s loan.

Agency guidance: SBA SOP 50 10 8, effective June 1, 2025; SOP 50 10 8.1, announced by SBA notice 5000-880695 (August 14, 2026), applicable to loans numbered on or after October 1, 2026.

What should I do before the next draft of the purchase agreement arrives?

Four concrete steps, in order, this month. Each one is something you can do with your accountant and your deal counsel before the buyer sends the next turn of the purchase agreement, and each one narrows the range of outcomes in your favor.

• Pull the schedule that set your price. Find the adjusted EBITDA or revenue schedule the buyer relied on. It is the starting point for the definition, and it is evidence.
• Run the definition backward over last year. Apply the proposed metric to your last completed fiscal year. If the result lands below the pricing number, you found the problem early.
• Choose your metric on control, not optics. If you will not run the business, push toward revenue or milestones. If you will run it with real autonomy, EBITDA is defensible with the exclusion list written out.
• Calendar the objection window on signing. Put the delivery date, the deadline and a two-week reminder in your own calendar, not the buyer’s. Then object in writing, with particulars.

The metric decides how hard your earn-out is to measure. The definition decides who wins the measurement. The deadline decides whether you get to argue. Get all three right and the earn-out becomes what it was meant to be: the rest of your price, paid late.