In mergers and acquisitions (M&A) involving Chinese listed companies, Earn-back mechanisms are often standard practice. However, some portfolio companies fail to meet performance targets due to subjective or objective reasons[1]. When compensation obligations arise, promisors may default, forcing listed companies to resort to litigation or arbitration to enforce commitments[2]. Even after prevailing in court, recovery may prove challenging[3]. Consequently, listed companies have increasingly adopted Earnout mechanisms in recent years[4]. Indeed, Earn-outs are a common transactional arrangement in international M&A.
I. Definition of Earn-out Mechanism
An Earn-out mechanism is employed when parties to an M&A transaction cannot agree on the valuation of target assets or entities. It provides that the Acquirer will pay additional consideration if the target achieves predetermined objectives (the "Target Metrics") within a specified post-closing period. Payment is contingent solely on achieving these metrics; if unmet, no further payment is due. Thus, it constitutes contingent consideration.
Similar to Earn-back mechanisms, Earnouts are typically used in transactions where valuation disagreements arise from information asymmetry or divergent views on the portfolio companies’ future profitability. To bridge this gap, the Transferor commits to future performance under an Earn-back structure, compensating the Acquirer if targets are missed. Conversely, under an Earnout, the Acquirer pays an initial sum reflecting its valuation at closing, with additional consideration payable only if the target achieves metrics advocated by the transferor. This balances the transferor’s interests. While financial metrics (e.g., profitability) are common, nonfinancial targets, such as R&D milestones in pharmaceutical acquisitions, may also serve as Earn-out criteria.
Notably, Earn-outs afford greater control to Acquirers compared to Earn-back structures. Thus, transferors must carefully consider risk mitigation strategies under such mechanisms.
II. Earn-out Provisions
Though prevalent in cross-border M&A, Earn-out clauses are among the most dispute-prone contractual terms. Disputes typically center on: (a) whether Target Metrics were achieved, and (b) the causes of any failure. Consequently, the drafting of Earn-out terms mandates meticulous attention to: (i) determinacy of performance targets; (ii) coherence of contractual logic; (iii) mitigation protocols for achievement barriers.
1. Precisely definition of Financial Metrics
Target Metrics may be financial (e.g., net profit, EBIT/EBITDA, revenue growth over 2–3 years) or nonfinancial. Despite their quantitative nature, financial metrics are susceptible to interpretive conflicts arising from accounting methodologies. In one cross-border deal we advised on, the parties used a three-year gross profit compound annual growth rate (CAGR) to determine contingent payments. To preempt disputes, we:
- Explicitly defined gross profit, base gross profit, and gross profit CAGR;
- Detailed calculation methodologies (including relevant accounting line items) and pricing formulas via tables and notes;
- Instituted an independent expert resolution process for pricing disputes.
In another transaction involving EBITDA CAGR targets, bespoke adjustments (e.g., excluding government subsidies, rent modifications) were incorporated.
2. Objective, Operable, and Logically Sound Non-financial Metrics
Non-financial metrics may include KPIs, production/sales volumes, market share, daily active users (DAU), R&D milestones, key contract executions, product launches, or clinical trial phases. Metric based targets should emulate the precision applied to financial metrics. Milestone based targets require multidimensional definitions to ensure objectivity and operability. Where multiple milestones exist, logical sequencing must avoid ambiguity.
In a share transfer dispute we handled, the agreement included both net profit targets and phased DAU metrics. While cumulative DAU and net profit were achieved, one interim DAU phase was missed. The Transferor argued for aggregate assessment; the Acquirer insisted on phased compliance. The dispute arose from insufficient logical integration of the metrics.
In another deal involving a lithium iron phosphate cathode producer, the Transferor claimed ongoing negotiations with CATL for a long-term supply agreement. Given uncertainty, the Acquirer proposed tying a lumpsum payment to the execution of such an agreement. In drafting the Earn-out provisions, we established the following conditions from the Acquirer’s perspective for the long-term supply agreement: required duration, minimum annual sales volume, minimum annual sales value as well as operational performance commitments. While the Transferor negotiated expansions to product categories and permitted buyer scope. Such considerations culminate in a definitive agreement between the Parties.
3. Critical for Target Achievement: Operational Control
Acquirers often retain the transferor’s management or R&D team during the Earn-out period to ensure transition stability. However, if the management rights of the parties are not clearly delineated in the M&A agreement, disputes will inevitably arise.
In a share transfer dispute, the parties verbally agreed that the Transferor (Mr. Xu) would remain as General Manager (GM) for three years post-closing. The agreement, however, merely appointed him to the five-member board, which retained GM hiring/firing authority. Post-closing, irreconcilable conflicts between Xu and the board-chair (appointed by the Acquirer) led to Xu’s removal and termination. Deprived of operational control, Xu failed to meet the Earn-out targets, finally the Acquirer withheld 40% of the consideration.
While the Acquirer’s actions were legally defensible under corporate law, they undermined the transferor’s interests. Such cases, common under Earn-back mechanisms[5] highlight the need to explicitly define operational rights and remedies for interference.
In a cross-border deal we advised, the Acquirer proposed standard corporate governance (shareholder supremacy). Representing the transferor, we:
- Exhaustively enumerated shareholder and board powers;
- Reserved all residual authority to the GM (to be appointed by the transferor);
- Stipulated that Acquirer interference with GM authority would trigger deemed Earn-out achievement and full payment;
- Negotiated liquidated damages for specified interference (subject to dispute resolution).
This balanced solution accounted for the parties’ bargaining power and operational priorities. Where Acquirers demand operational control, defining both metrics and management boundaries becomes paramount.
4. Other Factors Impacting Target Achievement
Any variable affecting Target Metrics warrants quantification. For instance, during negotiations for an 2018 cross-border deal amid escalating Sino-US trade tensions, we analyzed potential tariff impacts and incorporated tiered adjustment mechanisms for each tariff scenario into the Earn-out terms.
Conclusion
Earn-outs are increasingly prevalent in both cross-border and domestic M&A. It is suggested that transferors should formulate realistic projections of target profitability, collaborate on balanced valuations, as well as diligently draft and perform agreements with legal counsel. These steps are essential to achieve Target Metrics and secure expected returns.
About the Author
Chambers (Chunbao) Yang, a Senior Partner, Head of the Capital Markets Department, and Director of the State-Owned Fund Research Center at Dacheng Law Offices LLP (Shanghai). He also serves as the Leader of the Private Equity and Investment Funds Practice Group for Dacheng China and is a member of the Shanghai Foreign-Related Legal Talents Pool. He holds a Bachelor of Laws from Fudan University (1992), a Master of Laws from the University of Technology Sydney (2001), and a Master of Laws from East China University of Political Science and Law (2001).
With 30 years of legal practice, Mr. Yang has long been engaged in legal services related to private equity funds, investment and financing, and mergers and acquisitions, covering industries such as large finance, large health, real estate and infrastructure, TMT (Technology, Media, and Telecommunications), exhibition industry, and manufacturing. Since 2004, he has been repeatedly listed in The Legal 500's rankings for "Private Equity" and "Corporate and Commercial" sectors, and has been specially recommended or commented on by Asia Law Profiles on multiple occasions. Since 2016, he has been continuously selected into the "Top 100 PRC Elite Lawyer" by China Business Law Journal. He was awarded the title of "China Corporate Law Expert of the Year" at the Leaders in Law - 2021 Global Awards, and has been consistently listed in the Recommended Directory of Excellent Lawyers Recommended by General Counsel of Well-Known Chinese Enterprises. He has also won awards such as "China TMT Lawyer of the Year" and "China M&A Lawyer of the Year" from Lawyer Monthly and Finance Monthly on multiple occasions.
Mr. Yang is qualified to serve as an independent director of listed companies. He is a part-time professor at the School of Law of East China University of Science and Technology, a practical tutor at the Law School of Fudan University, a part-time graduate tutor at East China University of Political Science and Law, a lecturer for the Private Equity CEO Program at Shanghai Jiao Tong University, and a lecturer for the Transnational Operation Talent Training Program of the Shanghai Municipal Commission of Commerce. He has published 16 monographs, including Practical Operations for Risk Prevention and Control in Private Equity Investment Funds, Practical Operations and Case Analysis of Enterprise-Wide Legal Risk Prevention and Control, and Winning Capital 2: A Complete Operation Guide to Corporate Investment and Financing Modes and Processes.
Mr. Yang's practice areas include: corporate law, investment, mergers and acquisitions, and private equity funds, capital markets, TMT, real estate and construction engineering, as well as dispute resolution in the aforementioned fields.
Email: chambers.yang@dentons.cn
Tel: +86 13901826830
Footnotes:
[1]: See 24 Listed Companies’ M&A Targets Defaulted on Earn-back Obligations; Litigation Ensues, Xinhua News Agency (Dec. 14, 2017).
[2]: E.g., DunAn Environment announced on Aug. 28, 2019, that it filed a lawsuit with Shaoxing Intermediate People’s Court against the target’s former controller Qiu Shaojie for compensation.
[3]: Hongda Mining announced a favorable court judgment on June 19, 2019, but noted that enforcement against shares held by the defaulting shareholder faced challenges due to third-party liens.
[4]: E.g., Shanghai Shenkai’s acquisition of 60% equity in Hangzhou Fenghe, with Earnout payments tied to net profit.
[5]: See M&A disputes involving listed companies such as Shinva Medical and Blue Focus.
杨春宝一级律师简介
杨春宝一级律师，大成上海高级合伙人、资本市场部主任、国资基金研究中心主任，大成中国区私募基金专业带头人、科技与文化法律研究中心联合牵头人。执业30余年，长期从事私募基金、投融资、并购重组法律服务，尤其对对赌研究颇深且具有非常丰富的实战经验，并专注于金融机构股权投资业务。2004年起多次入选The Legal 500"私募基金"和"公司与商业"等境内外各类律师榜单，代理的中国法院首例适用外国法律审理外国公司的董事损害小股东权益纠纷案入选上海高院发布的《上海法院域外法查明典型案例》和威科先行"要案头条"。入选上海涉外法律人才库、上海市司法局鼎新法治人才库、上海国有企业改制法律顾问团，具有上市公司独立董事任职资格，系多家知名高校的兼职教授或兼职研究生导师及上海市商务委跨国经营人才培训班讲师。出版《私募股权投资基金风险防控操作实务》等16本投融资法律专著。了解更多常见法律问题
什么是Earn-out机制及其法律性质？
①Earn-out机制是并购交易中因交易双方对标的资产或目标公司的估值无法达成一致而采用的一种或有对价安排。其法律性质属于附条件的股权转让价款支付条款，核心在于收购方在交割时先支付基础价款，若标的在未来约定期限内实现预定业绩目标，则收购方再支付额外对价。该机制的依据是合同法中的附条件民事法律行为规则，条件的成就与否直接决定转让方能否取得后续价款，因此转让方对业绩目标的可实现性承担实质风险。②在实务中，Earn-out机制常见于跨境并购及上市公司并购重组交易。文章指出，与Earn-back机制（业绩未达标时转让方补偿收购方）不同，Earn-out机制下收购方享有更大控制权，转让方需在业绩考核期内持续配合经营。例如，在某锂电材料企业交易中，双方以与宁德时代签订长期供货协议作为付款条件，此类条件具有高度不确定性，反映出Earn-out对价高度依赖未来经营事件。③转让方应充分认识该机制的法律后果：若业绩目标未达成，无论原因是否可归责于转让方，收购方通常有权不支付后续对价。因此，在签约前应审慎评估业绩目标的合理性，并在协议中明确业绩未达成的例外情形，如因收购方干预经营导致的业绩不达标应视为条件已成就，以防范控制权与收益权失衡的风险。
财务业绩指标如何约定才能避免争议？
①财务业绩指标是Earn-out机制中最常见的考核标准，通常包括净利润、EBIT/EBITDA、营业收入增长率、毛利率复合增长率等。由于财务数据依赖会计准则和会计政策的选择，同一经济事项可能因会计处理差异导致不同结果，因此法律概念上必须对指标内涵进行精确界定。核心规则是明确各项财务指标的构成范围、计算基础和调整事项，避免使用模糊用语。②文章举例说明，在一笔跨境交易中，双方约定以三年毛利率复合年增长率作为或有对价支付条件。为防范争议，操作上明确界定了毛利率、基础毛利率及复合增长率的定义，详细列明计算方式涉及的会计科目，并通过表格和注释呈现定价公式，还设定了独立的专家解决机制。另一笔涉及EBITDA复合增长率的交易中，则通过量身定制调整项，排除政府补贴、租金变更等因素的干扰。③实务中，转让方应重点关注财务指标的计算口径是否与行业惯例及公司实际经营状况匹配，尤其要警惕收购方利用会计估计变更或合并报表范围调整来操控指标结果。建议在协议中约定审计机构的选择权归属、争议发生时由独立第三方复核的机制，并明确非经常性损益、关联交易等特殊事项的处理规则，从而降低财务指标被单方操纵的风险。
非财务业绩指标设定应注意哪些问题？
①非财务业绩指标涵盖KPI、产销量、市场份额、日活跃用户数（DAU）、研发里程碑、关键合同签署、产品上市或临床试验阶段等。其法律性质属于合同中的业绩条件条款，需要具备客观性、可操作性和内在逻辑一致性。对于基于数值的指标，应像财务指标一样精确界定；对于基于里程碑的指标，则需从时间、质量、数量等多维度进行定义，并合理安排各里程碑之间的逻辑顺序。②文章分享了一个股权转让纠纷案例：协议同时约定净利润目标和分阶段的DAU指标，虽然累计DAU和净利润均达成，但某一阶段的DAU未达标，转让方主张按累计数考核，收购方主张按阶段考核，争议根源在于条款未明确多指标之间的逻辑关系。另一个案例涉及磷酸铁锂正极材料企业，转让方声称与宁德时代洽谈长期供货协议，收购方据此将签署该协议作为付款条件，起草时对供货期限、最低年销量、最低年销售额及运营业绩承诺均作出详细约定。③实务指引上，转让方应避免接受意义含糊的指标表述，如市场占有率提升、重大合同签署等，必须明确衡量标准和证据要求。若存在多个指标，应明确是全部满足还是部分满足，以及各指标是否具有累积计算或替代关系。同时建议设置指标调整机制，当不可抗力或情势变更导致目标无法实现时，允许重新谈判或按公平原则调整，防止因过苛条件导致权利义务失衡。
以上内容仅供参考，不构成法律意见。如需专业法律服务，请联系杨春宝一级律师：chambers.yang@dentons.cn
