When you sell your Minnesota business with an earnout, you agree to take part of the price later, contingent on the business hitting performance targets after you no longer run it. That structure can bridge a real gap between what you think the company is worth and what the buyer will commit to today. It also hands the buyer control of the very numbers your remaining payment depends on. Minnesota has no statute that defines or regulates earnouts, so the contract language and ordinary common-law contract construction control almost everything that matters. In my practice advising sellers and buyers on Minnesota business acquisitions, the earnouts that cause trouble are almost always the ones where the metric was loosely defined and the buyer’s post-closing obligations were left vague.
What is an earnout in a Minnesota business sale?
An earnout is a contract term that splits the purchase price into a portion paid at closing and a portion paid later if the business meets agreed performance targets. Minnesota has no earnout statute. Courts treat the earnout the way they treat any negotiated commercial term: they read the contract, apply ordinary rules of contract construction, and enforce what the parties actually wrote. There is no statutory default that fills gaps in your favor.
That makes the drafting load heavier than most sellers expect. The earnout has to define the performance metric, the measurement period, the calculation method, the payment schedule, any cap or floor, and what happens if the business changes hands or changes direction during the earnout window. An earnout is not the same as a purchase price true-up clause, which corrects the closing balance sheet for working capital and similar items. The true-up looks backward at closing-date facts; the earnout looks forward at performance you no longer control.
When does an earnout make sense for a Minnesota seller?
An earnout makes sense when the buyer and seller genuinely disagree on value and the disagreement is about the future. If you believe the company will grow and the buyer is pricing in flat performance, an earnout lets you get paid for the growth if it actually arrives, instead of arguing about a forecast at the closing table. It is a price-gap bridge.
The cost is that the earnout converts a clean exit into a multi-year relationship in which the buyer controls the business and you carry the performance risk. Three questions decide whether the trade is worth it. First, how much of the total price is contingent: a 10 percent earnout is a modest bet, a 50 percent earnout means you have effectively financed half the sale. Second, how measurable the target is: a binary milestone is cleaner than a multi-input profit figure. Third, how much influence you keep: a seller who stays on as a manager can protect the metric, while a seller who walks away depends entirely on the buyer’s good faith and the contract’s covenants. If most of your price is contingent, the metric is soft, and you have no operating role, an earnout is a weak structure for you.
How is an earnout metric chosen, and which metric protects the seller?
The metric is whatever the contract names. The three common choices are a revenue target, an earnings figure such as EBITDA, and a discrete milestone like a contract renewal or a regulatory approval. Each shifts manipulation risk differently, and the choice matters more than any other single earnout term.
Revenue is the hardest metric for a buyer to depress, because revenue is a top-line number that resists accounting adjustment. Its weakness is the reverse: a buyer can hit a revenue target with unprofitable sales, so a pure revenue earnout can pay out even when the business is not actually healthier. An earnings metric like EBITDA is the most exposed to buyer conduct, because earnings depend on cost allocation, intercompany charges, management fees, and integration expenses that the buyer largely controls after closing. A milestone metric is the cleanest when the milestone is genuinely binary and outside the buyer’s discretion. Many sellers compare an earnout against contingent value rights as an alternative to an earnout, which can carry the same milestone logic in a more defined instrument. As a general rule, the more discretion the buyer has over the inputs to the metric, the more drafting protection the seller needs.
How does the implied covenant of good faith and fair dealing protect an earnout?
Minnesota courts imply a covenant of good faith and fair dealing into commercial contracts, and that covenant is the seller’s main protection against a buyer who tries to defeat the earnout. The Minnesota Supreme Court has framed the covenant as a duty not to “unjustifiably hinder” the other party’s performance of the contract (In re Hennepin County 1986 Recycling Bond Litigation, 540 N.W.2d 494, 502 (Minn. 1995)). Minnesota’s Uniform Commercial Code states the principle directly for transactions it governs: under Minn. Stat. § 336.1-304, “Every contract or duty within the Uniform Commercial Code imposes an obligation of good faith in its performance and enforcement.” The statutory definition gives the term real content. Under Minn. Stat. § 336.1-201, good faith “means honesty in fact and the observance of reasonable commercial standards of fair dealing.” It has both a subjective side, honest intent, and an objective side, commercially reasonable conduct.
Here is the limit a seller has to understand. Read against the “unjustifiable hindrance” standard, the covenant generally reaches a buyer who takes deliberate action to undermine the earnout metric, such as steering revenue to an affiliate or loading unrelated costs into the earnout period to suppress earnings. It has not generally been read to require the buyer to run the business so as to maximize your payout. In practice, a buyer can make ordinary business decisions that happen to reduce the earnout, as long as the decisions are not a bad-faith effort to deprive you of the payment. The covenant has been applied to police interference, rather than to impose a duty to optimize. That gap between “do not sabotage” and “must maximize” is exactly where earnout disputes live, and it is why the covenant alone is not enough protection.
How do I keep the buyer from gaming the earnout metric?
The reliable protection is contractual, not the implied covenant. Because the covenant only reaches bad-faith interference, a seller who wants real protection writes it into the agreement. Four drafting moves carry most of the weight.
- Define the metric precisely. Spell out exactly what counts toward revenue or earnings, including how returns, discounts, and one-time items are treated. A metric defined in a sentence invites a fight; a metric defined in a schedule does not.
- Lock the accounting method. State that the metric is computed using the same accounting principles, applied consistently, that the business used before closing. This stops the buyer from changing accounting policy to reshape the number.
- Restrict cost allocations and intercompany dealings. Bar the buyer from charging management fees, allocating corporate overhead, or routing intercompany transactions in a way that depresses the metric during the earnout period.
- Impose express operating covenants. Require the buyer to operate the business consistently with past practice, maintain the sales force, fund it at agreed levels, or whatever else the metric depends on. Express covenants give you a breach-of-contract claim that does not depend on proving bad faith.
These covenants do the same protective work for the seller that surviving representations do for a buyer. For how post-closing promises hold up, see which representations survive the closing. With express covenants in place, the implied covenant becomes a backstop for conduct you did not anticipate, instead of your only line of defense.
What happens to my earnout if the buyer sells the business mid-earnout?
Minnesota law does not stop a buyer from reselling the business, merging it, or transferring its assets during the earnout period. There is no statute that freezes the company in place while your earnout runs. Your protection is whatever the contract says, so a well-drafted earnout addresses a change of control head-on.
A seller-protective earnout typically does one of three things if the buyer sells or merges the business mid-earnout. It can accelerate the earnout, so a sale triggers immediate payment of the full or a formula-based amount. It can require any successor to expressly assume the earnout obligation as a condition of the deal. Or it can switch to a deemed-earned formula that estimates the earnout based on performance to date. Without one of these, a resale can strip the metric out from under you, leaving you to argue that the buyer structured the sale to defeat the earnout. That argument runs through the implied covenant discussed above, and it is a hard, fact-intensive claim. It is far better to control the outcome with explicit change-of-control language than to litigate the buyer’s intent after the business is gone. A buyer’s resale can also raise Minnesota successor liability in asset sales questions, which is a separate reason to define successor obligations clearly.
How can I secure an earnout payment so I actually get paid?
An earnout is an unsecured promise unless the contract makes it something more. If you take a bare earnout and the buyer later cannot or will not pay, you hold a contract claim and nothing else, and you stand behind the buyer’s secured lenders. Minnesota sellers use four tools to convert that bare promise into a real recovery path.
The first is an escrow or holdback: a portion of the price is held by a third party or retained by the buyer and released as the earnout is earned, so the money exists before the dispute does. The second is a security interest in the business assets, perfected as a UCC Article 9 security interest, which gives the seller collateral and a priority position. The third is a guaranty from the buyer’s parent company or principals, adding a second party to collect from. The fourth is a setoff right against a seller note, where the seller financed part of the price and can offset an unpaid earnout against what the seller still owes. These tools are not mutually exclusive, and the right combination depends on the buyer’s balance sheet and how much of the price is contingent.
How should an earnout dispute be resolved under Minnesota law?
Most earnout disputes are accounting disputes, not contract-interpretation disputes, so the contract should pick the forum in advance and split it by issue type. The standard approach is two tracks. Measurement questions, meaning disagreements about how the metric was calculated, go to an independent accountant whose determination binds both parties. Everything else, meaning genuine disputes about what the contract means or whether the buyer breached a covenant, goes to litigation or to arbitration.
If the agreement selects arbitration, Minnesota law makes that choice enforceable. Under the Minnesota Revised Uniform Arbitration Act, Minn. Stat. § 572B.06, an agreement to submit a controversy to arbitration “is valid, enforceable, and irrevocable except upon a ground that exists at law or in equity for the revocation of contract.” In my experience, the earnout disputes that turn ugly are the ones with no accountant-determination clause, where a routine question about cost allocation becomes a full lawsuit because the contract gave it nowhere else to go. Deciding the forum while both sides are still cooperative is far cheaper than deciding it after the relationship has soured.
How is an earnout taxed when you sell a Minnesota business?
An earnout paid in a later year is, by definition, an installment sale under federal law. IRC § 453 defines an installment sale as a disposition of property “where at least 1 payment is to be received after the close of the taxable year in which the disposition occurs,” and provides that income from an installment sale is taken into account “under the installment method.” In practice, that means your gain is generally spread across the years the earnout payments actually arrive, rather than taxed in full at closing.
Two complications deserve attention, and both reward early planning. First, a multi-year earnout should carry a market rate of interest. If it does not, the federal imputed-interest rules under IRC § 483 and IRC § 1274 recharacterize part of each payment as ordinary interest income, which is taxed at a higher rate than capital gain. Second, there is a Minnesota overlay. Under Minn. Stat. § 290.0137, a seller who is, or who becomes, a nonresident must include in Minnesota taxable income the full amount realized on a sale of a Minnesota S corporation or partnership interest, “including any income or gain to be recognized in future years pursuant to an installment sale method.” The same statute lets a nonresident seller elect to defer that recognition instead. A seller planning to leave Minnesota after the sale should confirm the current statute and Department of Revenue guidance before assuming the earnout will be taxed year by year. Earnout tax treatment also turns on whether the IRS views the payments as purchase price or as compensation, which is a separate analysis worth running before the deal closes.
Can the buyer fire me during the earnout period?
If you stay on as an at-will employee, the buyer can generally end that employment. The earnout itself is a separate contract right, so the buyer firing you does not erase what you have already earned. A well-drafted earnout addresses this directly, often by making a without-cause termination an acceleration event or a deemed-earned trigger.
Do I owe tax on an earnout payment before I receive it?
Generally no for the contingent portion. Under the federal installment method, you recognize gain as payments arrive, not all at closing. One exception to watch: a large installment sale can trigger a federal interest charge on the deferred tax once the sales price and outstanding obligations cross statutory dollar thresholds.
Is an earnout the same as a purchase price adjustment?
No. A purchase price adjustment, often called a true-up, corrects the closing-date balance sheet for items like working capital. An earnout pays you for the business’s future performance, which you no longer control once the buyer owns the company. They solve different problems and carry different risks.
Can I be made to sign a noncompete after selling, even after Minnesota's noncompete ban?
Yes. Minnesota’s 2023 law makes most noncompetes void and unenforceable, but a separate provision keeps a noncompete valid when it is agreed on during the sale of a business and is reasonable in time and geography. A seller noncompete tied to your sale is on the enforceable side of that line.
What if the buyer and I disagree on whether the earnout target was hit?
The contract controls. A well-drafted earnout routes a measurement disagreement to an independent accountant whose determination binds both sides. That keeps an accounting dispute out of court. If the contract is silent, the disagreement becomes a contract claim like any other.
Is a guaranty enough to protect my earnout?
A guaranty helps, but it is only as good as the guarantor. A parent-company or individual guaranty gives you a second party to collect from if the buyer entity cannot pay. Many sellers pair it with an escrow, a holdback, or a security interest in the business assets for a fuller safety net.
Bottom Line
An earnout can be a fair way to close a price gap when you and a buyer disagree about your Minnesota company’s future. Because Minnesota does not regulate earnouts by statute, the contract carries the entire load: the metric definition, the buyer’s operating covenants, the change-of-control language, the security for payment, and the dispute-resolution forum. The implied covenant of good faith and fair dealing is a real protection, but it only reaches bad-faith interference, so it is a backstop and not a substitute for precise drafting. For the wider context of a sale, see the broader process of selling a Minnesota business and our business acquisitions practice. If you are weighing an earnout in the sale of your business, email [email protected] with a brief description to start an intake and conflict check before sending any confidential deal documents.
