Earnouts and Contingent Consideration in M&A

Introduction

In 2025, AbbVie charged $6.5 billion to its earnings for the change in fair value of contingent consideration, almost as much as its $7.4 billion of amortization on acquired intangible assets. The charge did not come from a failed deal. It came from success: higher expected sales of Skyrizi, its immunology drug, on which AbbVie owes payments linked to future sales of products it acquired, together with lower discount rates and a longer expected payment period. By the end of the year, AbbVie carried $25.4 billion of contingent consideration liabilities on its balance sheet, as its 2025 annual report shows.

Contingent consideration, often called an earnout, is part of the price of an acquisition that depends on what happens after closing. The accounting records it at fair value from the start and then follows its value until it is paid, producing some of the most counterintuitive figures in an acquirer's income statement.

Buyers and sellers often disagree about a business's prospects. A seller convinced that a new product will succeed wants to be paid for it; a buyer that doubts it does not want to pay in advance. An earnout bridges the gap: part of the price is paid only if the business reaches agreed targets, such as revenue, earnings before interest, taxes, depreciation and amortization (EBITDA), a regulatory approval or sales of a product.

Contingent consideration

An obligation of the acquirer to transfer additional assets or equity to the former owners of an acquired business if specified future events occur or conditions are met. Under Accounting Standards Codification (ASC) 805 it is part of the consideration transferred and is recognized at its acquisition-date fair value. It can also give the acquirer a right to the return of previously paid consideration if conditions are met.

The forms vary by industry. Private company deals often pay an earnout if revenue or EBITDA exceeds a threshold over two or three years. Pharmaceutical deals tie payments to regulatory and commercial milestones or to royalties on sales. Public company deals sometimes use contingent value rights, tradable or non-tradable instruments that pay the target's shareholders if a milestone is reached, such as approval of a drug by a set date.

Not every contingent payment in a deal is contingent consideration under ASC 805. Milestones owed on a purchase of assets that do not make up a business, such as a single drug candidate, are generally recognized only when they become probable and estimable, as described in business combination or asset acquisition?. And contingent payments the target itself owes for its own earlier acquisitions are liabilities assumed, measured at fair value like the target's other liabilities, rather than part of the price the buyer pays.

Contingent value right

An instrument issued to a target's shareholders in an acquisition that entitles them to an additional payment, usually in cash, if a specified event occurs, such as regulatory approval of a product or sales above a threshold by a set date. For the acquirer, a contingent value right is contingent consideration, recognized at fair value at closing and generally classified as a liability.

At the acquisition date, the buyer estimates the fair value of the contingent payments and includes it in the consideration transferred, so it increases goodwill, as covered in the acquisition method. The valuation reflects the probability and timing of each outcome, discounted to present value. AbbVie uses probability-weighted expected payment models for milestones and Monte Carlo simulations for royalties.

Liability or Equity

The classification of the obligation decides what happens next. An earnout payable in cash, or in a variable number of shares worth a fixed amount, is a liability. An earnout payable in a fixed number of the buyer's shares may qualify as equity under the rules on contracts in an entity's own stock (ASC 480 and ASC 815-40). Liability-classified earnouts are remeasured at every reporting date; equity-classified ones are not, and their settlement is recorded within equity.

Many earnouts are paid to sellers who stay with the business as managers. Under ASC 805-10-55-25, if the payment is automatically forfeited when a seller's employment ends, it is not part of the price at all but compensation for future services, recognized as expense over the service period rather than as consideration, as PwC's guide to contingent payments to employees explains. Other indicators, such as whether the selling employees receive more than other sellers or whether the payment period matches the required employment, are weighed when the link to employment is less direct. Compensation treatment can turn a deal that looks cheap on paper into one with years of expense, the same logic that applies to replacement awards in stock-based compensation accounting.

A liability-classified earnout is remeasured to fair value each period until it is settled, and the changes go through earnings, not goodwill. Only adjustments during the measurement period that reflect facts existing at closing change goodwill. Counterintuitively, when the acquired business does well, the expected payment rises and the buyer records a loss; when it disappoints, the liability falls and the buyer records a gain, often in the same period as an impairment of the business's goodwill or intangibles. The passage of time also increases the liability, because the discount unwinds as payment approaches.

AbbVie's roll-forward shows how large these movements can become:

Over three years, AbbVie charged $15.4 billion of remeasurements to earnings while paying $6.5 billion in cash. The weighted average discount rate in its valuation fell from 4.8% to 4.0% in 2025, which on its own raised the liability.

Where the Payments Appear in Cash Flow

Under ASC 230, the cash flow classification of earnout payments depends on timing and amount. Payments made soon after the acquisition are investing outflows, like the rest of the price. Later payments are split: the part up to the liability's fair value at the acquisition date is a financing outflow, and any excess, reflecting increases since closing, is an operating outflow. AbbVie's 2023 payments were split between $752 million in financing activities and $870 million in operating activities; in 2024 and 2025, all its payments were operating, consistent with cumulative payments having passed the liabilities' original fair value. For a buyer whose earnouts have grown, the cash paid reduces operating cash flow, a point to remember when reading cash flow from financing activities and operating cash flow together.

In valuation, an earnout liability is a claim on the business that the acquirer still has to pay. Bankers typically treat its fair value, or their own estimate of the expected payments, as a debt-like item in the bridge from equity value to enterprise value. For AbbVie, $25.4 billion of contingent consideration equals about 40% of its $64.5 billion of long-term debt, and $3.5 billion of it is expected to be paid within a year.

In earnings analysis, remeasurement gains and losses are excluded from adjusted earnings, alongside the other items in one-time items: restructuring, impairments and gains, because they reflect revisions to the price of past deals rather than operations. But the cash payments are real and recurring for an acquirer like AbbVie, so they belong in any assessment of its free cash flow.

Negotiating the Terms

For deal negotiation, the structure of an earnout matters as much as its size. Targets defined on revenue are harder for the buyer to influence than targets defined on EBITDA, which depend on how costs are allocated after integration, and earnout calculations are a frequent source of post-closing disputes. Clear definitions, an agreed accounting basis and a mechanism for resolving disagreements are part of what makes an earnout worth its fair value.