Recent Delaware Case Highlights Common Pitfalls to Avoid With Earn-Out Provisions

Most people in the M&A business have encountered earn-outs in one form or another in attempting to structure transactions to close pricing gaps between buyers and sellers. Most also know that earn-out provisions often involve contentious negotiation and, frequently, disputes, sometimes leading to litigation. A recent case in the Delaware Court of Chancery, Airborne Health, Inc. and Weil, Gotshal & Manges LLP v. Squid Soap, LP (November 23, 2009), is yet another example of the propensity of earn-outs to go bad and provides reminders of common pitfalls parties should attempt to avoid when drafting these provisions.

Squid Soap had developed a germ-prevention product for children designed to increase the amount of time they spend washing their hands. Airborne Health, a maker of dietary supplements to support the immune system, acquired Squid Soap's assets under an agreement that paid Squid Soap $1 million at closing, with an earn-out of up to an additional $26.5 million