Earnout Drafting Risks in Indian Startup Acquisitions
An earnout can bridge a valuation gap when an acquirer believes an Indian technology company will hit revenue, product or customer milestones after closing, while founders believe that value is already visible. It can also turn a clean acquisition into a prolonged dispute if the parties agree on the headline number but not the operating rules that produce it.
For strategic acquirers, PE funds and founders, the core question is not whether an earnout is “standard.” It is whether the metric can be measured after the business moves under a new owner, and whether the seller has a credible remedy if post-closing decisions change the result.
Start With the Legal and Deal Perimeter
The Indian Contract Act, 1872 is the starting point: the payment promise, its conditions, the consequences of non-performance and the agreed dispute mechanism should be written with precision. A vague promise to pay founders if the company “performs well” is a commercial aspiration, not an acquisition-grade payment architecture.
The Companies Act, 2013 matters because the transaction documents, board approvals, authority to sign, financial reporting and continuing corporate actions must fit the chosen structure. In a cross-border deal, parties should also screen the payment and ownership route against the RBI’s Master Direction – Foreign Investment in India, rather than treating the earnout as an afterthought to signing.
Where the transaction may be a combination, the parties should separately assess notification and timing. The CCI’s Combination Regulations, 2024 and its combination FAQs are a useful official screening starting point. An earnout does not remove the need to examine the transaction as a whole.
Define the Metric Before the Multiple
Revenue, EBITDA, annual recurring revenue, customer retention, product delivery and regulatory milestones can all work in principle. Each creates a different allocation of risk. Revenue is susceptible to discounting, timing of invoicing and changes in sales strategy. EBITDA depends on accounting policies, shared costs, integration charges and allocations controlled by the buyer. Product milestones need objective acceptance criteria rather than a buyer’s unbounded satisfaction test.
The agreement should specify the accounting framework, the measurement period, treatment of acquisitions and divestments, foreign-exchange conversion, refunds, credits, bad debt, intercompany revenue and exceptional expenses. It should state whether the target is measured as a standalone business, a business unit or part of a combined group. A post-closing dashboard is useful, but it cannot repair an undefined formula.
Allocate Post-Closing Control Deliberately
Earnouts create a built-in tension: the acquirer owns the business, but the sellers care intensely about decisions that affect the metric. The buyer may need to reorganise sales, consolidate systems, change pricing or redirect engineers. The sellers need protection against conduct designed primarily to depress the earnout.
The practical answer is a calibrated covenant package. It can require operation in the ordinary course for specified decisions, prohibit deliberate diversion of target opportunities, preserve particular product lines for a defined period, or require consultation before material changes. It should not give former owners a veto over integration. Overly broad seller controls can undermine the buyer’s ability to run the acquired business and create its own dispute risk.
Build the Evidence and Dispute Path
An earnout clause should require periodic statements, access to the underlying records and a clear objection timetable. It should distinguish an arithmetic or accounting dispute, which may go to an independent accountant, from a broader contractual dispute, which may require arbitration or court proceedings. The clause should define the expert’s mandate, standard of review, cost allocation and whether the determination is final except for obvious error.
Also map responsibility for tax advice, withholding, employee or founder participation, escrow interaction and set-off rights. These are not boilerplate details. They determine whether the parties can calculate and pay the amount without reopening the purchase-price negotiation every quarter.
Common Mistakes
- Using a headline metric without definitions. “Revenue” and “EBITDA” can change materially with accounting, pricing, refunds and cost-allocation decisions.
- Giving one party unchecked control over the target’s result. A buyer needs integration flexibility, while sellers need tailored protection against deliberate value diversion.
- Leaving verification for later. Without statements, record access, an objection period and a defined expert process, even a small calculation issue can become a major dispute.
How KAS & Co. Can Help
KAS & Co. helps investors, acquirers and technology founders structure acquisition documents, test earnout metrics, align corporate approvals and identify post-closing dispute points before they affect value. For an earnout or acquisition-document review, contact KAS & Co..
FAQs
1. Are earnouts common in Indian startup acquisitions?
They are often used where parties disagree on future performance, founder retention or the value of a technology or customer pipeline. Their suitability depends on whether the proposed metric can be objectively measured after closing.
2. Should an earnout be based on revenue or EBITDA?
Neither is automatically better. Revenue may be easier to observe, while EBITDA may better reflect profitability; both need detailed definitions and safeguards against post-closing distortions.
3. Can the acquirer freely integrate the target during an earnout period?
Usually the buyer needs operational freedom, but the agreement should specify which integration actions are permitted and which conduct could unfairly affect the agreed metric.
4. How are earnout disputes usually handled?
The agreement can route narrow calculation disputes to an independent accountant and broader contractual disputes to the selected dispute-resolution process. The scope, timetable and finality of each path should be express.
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