Earnouts are risky, especially when your buyer has a pre-existing competitive business.
M&A Stories
December 6, 2024
In 2019, a seller of athletic event registration software agreed to sell its assets to a buyer in the same industry. The transaction included a $770,000 upfront payment and a potential $1.9 million earnout tied to post-closing revenue targets. The buyer, which already owned a competing business, was contractually obligated to use “commercially reasonable efforts to maximize the performance of the Business during the Measurement Period.”
The seller ultimately received no earnout and accused the buyer of diverting $2 million in revenue from specific athletic events to its pre-existing competing business. According to the seller, this diversion, coupled with the closure of the acquired operations, prevented it from achieving the earnout.
When the dispute reached a Delaware court, the buyer sought to dismiss the seller’s breach of contract claim, arguing it lacked sufficient factual support. The court disagreed, finding that the seller’s allegations of revenue diversion and business closure were detailed enough to move forward.
This case highlights a key risk for sellers in earnout agreements: when the buyer owns a pre-existing competing business, there is a clear incentive to prioritize the buyer’s operations at the expense of the seller’s earnout. Sellers should approach such arrangements cautiously and ensure the agreement includes strong protection to mitigate these risks.
See: I Am Athlete, LLC v. IM Enmotive, LLC, C.A. No. N24C-03-280 EMD CCLD, Superior Court of Delaware, (November 27, 2024).
Thank you for reading this blog. If you have any questions, insights, or if you’d like to engage in a more detailed discussion on this matter, I invite you to reach out directly.
Feel free to send me an email. I value thoughtful discussions and am always open to connecting with business owners, management, as well as professionals who share an interest in the complexities of M&A law.
By John McCauley: I write about recenegal problems of buyers and sellers of small businesses.
Email: jmccauley@mk-law.com
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Check out my books: Buying Assets of a Small Business: Problems Taken From Recent Legal Battles and Selling Assets of a Small Business: Problems Taken From Recent Legal Battles
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