The Earnout Paradox: Fewer Deals Use Them, More Money Rides on Them

Two credible sources describe the earnout market in 2026, and they appear to contradict each other. The American Bar Association's most recent study of private company deals found earnouts in only 18 percent of transactions, the lowest share recorded since 2006. Over roughly the same stretch, the total dollar value of private equity and venture capital exits carrying an earnout reached the highest annual figure in at least seven years. Both readings are accurate, and the space between them tells business owners something useful about where deal risk is now being placed.

What an Earnout Actually Is

An earnout is a portion of the purchase price a buyer pays only if the acquired business hits agreed targets after closing. Those targets are usually revenue, EBITDA (earnings before interest, taxes, depreciation, and amortization, the standard cash flow proxy in private transactions), or in regulated industries, a specific approval or product milestone. The structure exists to bridge disagreement. When a seller believes the business is worth eight times earnings and a buyer will only underwrite six, an earnout lets both sides sign the same document while leaving the difference to be settled by results.

That framing explains the apparent contradiction in the data. An earnout is a valuation gap tool. Where buyers and sellers broadly agree on price, the tool sits unused. Where they disagree sharply, it gets used heavily and for large sums.

Where the Structure Concentrates

The ABA study, which covered deals executed or completed in 2024 and the first quarter of 2025, showed earnout usage falling from 26 percent in the prior study period to 18 percent. Across the general run of private company M&A, valuation gaps narrowed and the tool became less necessary. Other deal terms moved in a modestly buyer-friendly direction over the same period.

The picture inverts in sectors where future performance is genuinely unknowable. In life sciences, earnouts appeared in roughly 89 percent of private biopharma transactions closing between mid-2023 and mid-2025, and in about 84 percent of medical device deals, up from 59 percent in the preceding two-year period. Contingent value rights, which pay defined amounts when post-closing milestones are met, now carry a growing share of total consideration in that sector while upfront payments shrink.

The middle market sits between these poles. Buyers continue to pay full prices for businesses with durable earnings, diversified customers, and management teams that can run the company without the founder. For everything else, the common response has not been to walk away or cut the headline number. It has been to move risk out of the closing payment and into earnouts and rollover equity.

What Delaware Decided in Early 2026

For most of the past decade, the practical objection to earnouts was straightforward: the seller surrenders control of the very business whose performance determines the remaining payment. Delaware courts spent the first months of 2026 addressing that problem directly, and the results are more balanced than either side might have expected.

The most significant decision came in January, when the Delaware Supreme Court ruled in Johnson & Johnson v. Fortis Advisors LLC. The dispute arose from J&J's acquisition of Auris Health, a medical robotics company, for $5.75 billion plus as much as $2.35 billion in earnouts tied to regulatory and commercial milestones. The court upheld the finding that the buyer had breached a specifically defined "commercially reasonable efforts" obligation, confirming that a negotiated efforts standard carries real weight. It also reversed in part, holding that the buyer was not required to pursue an alternative regulatory pathway the agreement did not specify.

The Court of Chancery reached a related conclusion in Fortis Advisors LLC v. Krafton, Inc., and Delaware's Superior Court allowed implied covenant claims to proceed in matters where buyers were alleged to have taken affirmative steps that undermined earnout payments. Read together, the 2026 decisions draw a workable boundary. Broad buyer discretion is not a license for bad faith, and internal communications suggesting a plan to avoid an earnout, paired with operating decisions that suppress the measured metric, create meaningful litigation exposure. At the same time, a buyer owes a seller the efforts the contract actually describes and not the efforts the seller wishes it had negotiated.

What This Means When You Are the Seller

The Delaware rulings reward precision in drafting and punish vagueness. Several practical consequences follow for an owner weighing a deal with a contingent component.

Define the metric with more care than the number. A revenue target sounds simple until the buyer folds your business into a larger division, changes the pricing model, or reallocates a shared customer relationship. EBITDA targets invite disputes over allocated corporate overhead, management fees, and integration costs. The measurement definition deserves at least as much negotiation as the dollar threshold, because it determines what the threshold is measured against.

Specify the effort standard rather than relying on general good faith. The Auris outcome turned on a clause the parties had defined themselves. Courts will enforce an obligation the contract describes; they are far less willing to construct one after the fact.

Build in visibility and acceleration. Reporting rights during the measurement period, access to underlying records, and a defined dispute resolution process cost little to negotiate and prevent the most common failure mode, which is discovering a shortfall only when the payment fails to arrive. Acceleration provisions covering a subsequent sale, a change of control, or the departure of key personnel protect against outcomes you have no ability to influence.

Account for tax treatment and time value. Contingent payments are generally taxed as received, and the money arrives one to three years after closing. A deal with a quarter of its value in an earnout is not equivalent to the same headline price paid in full at close, and it should not be evaluated as though it were.

What to Watch Next

Three developments are worth following from here. The first is whether earnout usage across general private M&A recovers as more owners bring businesses to market, or stays near its current low as valuation gaps continue to narrow. The second is how buyers respond to the Delaware decisions, which may push them toward broader discretion language and fewer defined efforts obligations, a shift sellers should be prepared to resist. The third is whether the life sciences model, in which most consideration is contingent, migrates into other sectors where outcomes hinge on regulatory approval or uncertain technology adoption.