Earnouts and Milestone-Based Payments in Healthcare M&A

Introduction

Earnouts are one of the most distinctive features of healthcare M&A. In sectors like technology or industrials, earnouts appear in perhaps 20-30% of transactions and are typically viewed as a negotiation fallback when buyer and seller cannot agree on price. In healthcare, earnouts are the norm, not the exception. They appear in roughly 71% of biopharma deals and 68% of device transactions because the fundamental value drivers in healthcare (clinical trial outcomes, FDA decisions, commercial adoption curves) are inherently uncertain and often binary. A drug either gets approved or it does not. A device either receives 510(k) clearance or it does not. These binary outcomes create valuation gaps that earnouts are specifically designed to bridge.

For healthcare bankers, structuring earnouts is a core competency. The difference between a well-structured and poorly-structured earnout can determine whether a deal closes, whether post-closing disputes arise, and whether the seller ultimately receives the full purchase price. Understanding the taxonomy of earnout triggers, the negotiation dynamics around operating obligations, and the common dispute patterns is essential for effective transaction advisory.

The fundamental problem earnouts solve is the valuation gap created by uncertain future outcomes. In a typical healthcare acquisition, the buyer and seller may agree on the value of current revenue and cash flows but disagree significantly on the value of pipeline assets, pending regulatory decisions, or early-stage commercial products.

Healthcare-Specific Drivers of Earnout Usage

Several features of healthcare M&A make earnouts particularly prevalent:

Binary regulatory outcomes. FDA approval is a yes/no event with no middle ground. A product either receives approval (and generates revenue) or it does not (and is worth nothing). This binary risk profile is perfectly suited to milestone-based earnouts.

Asymmetric information. The seller (often a biotech or device company that developed the product) typically has deeper knowledge of the asset's clinical and commercial potential than the buyer. Earnouts incentivize the seller to share accurate information because overstating the asset's potential would result in earnout milestones that are harder to achieve.

Long realization timelines. The value of a pipeline asset may not be fully realized for 3-7 years after closing (the time required for clinical development, regulatory review, and commercial launch). Earnouts extend the effective payment period to match this value realization timeline.

Milestone-Based Earnouts

Milestone earnouts pay a fixed amount upon the achievement of a specific, binary event. The event either occurs or it does not, and there is no sliding scale.

Biobucks

Industry slang for the total maximum value of milestone-based earnout payments in a biopharma transaction. When a deal is announced as "$2 billion upfront plus up to $3 billion in biobucks," the biobucks represent the cumulative value of all possible milestone payments if every clinical, regulatory, and commercial milestone is achieved. In practice, the probability-weighted value of biobucks is significantly less than the headline number because not all milestones will be achieved. Analysts typically apply probability of success adjustments to each milestone to estimate the expected value of the earnout. A deal with $3 billion in biobucks where the most significant milestone (Phase III success) has a 40% probability of success might have an expected earnout value of only $1-1.5 billion.

Milestone earnouts are preferred in biopharma because the milestones map directly to the clinical and regulatory value inflection points that create uncertainty. They are also cleaner to administer than financial earnouts because achievement is objectively determinable (the FDA either approves the drug or it does not).

Financial Earnouts

Financial earnouts pay amounts based on achieving financial targets, typically revenue or EBITDA thresholds. Payments may be fixed amounts triggered at specific thresholds (e.g., $100 million paid if revenue exceeds $500 million) or variable amounts calculated as a percentage of revenue above a baseline.

Financial earnouts are more common in healthcare services and device transactions, where the uncertainty is about commercial adoption rather than clinical or regulatory outcomes. A PE firm acquiring a physician practice management platform might include a financial earnout tied to same-store revenue growth or new location openings to bridge a valuation gap about the platform's growth trajectory.

Multiple Independent Milestones

Most healthcare earnouts include multiple independent milestones rather than a single trigger. This structure allows the seller to receive partial earnout payments even if some milestones are not achieved. A biotech deal might include separate milestones for Phase III data readout, FDA filing acceptance, FDA approval, and multiple revenue thresholds, each paying independently.

The independence of milestones matters for both negotiation and accounting. Under ASC 805 (business combinations), each milestone is evaluated separately for probability-weighted fair value at the acquisition date, and changes in fair value are recognized in earnings in subsequent periods.

Earnout Caps and Floors

Earnout Cap

The maximum aggregate amount payable under all earnout provisions combined. Caps protect the buyer from unlimited exposure while giving the seller meaningful upside participation. In healthcare, earnout caps typically range from 30-70% of the upfront purchase price (e.g., $2 billion upfront with a $1 billion earnout cap, making the maximum total consideration $3 billion). Higher caps (as a percentage of upfront) are more common in early-stage biopharma deals where a larger portion of the asset's value is contingent on future clinical outcomes.

Some earnouts include floors (minimum payments) or acceleration provisions that guarantee the seller receives a portion of the earnout regardless of milestone achievement, typically in exchange for accepting a lower upfront price. These structures are more common when the seller has strong negotiating leverage (competitive auction, multiple bidders).

Ordinary Course Obligations

The most contentious area of earnout negotiation is the buyer's obligation to operate the acquired business during the earnout period. The seller wants the buyer to commit to operating the business in a manner that maximizes the likelihood of achieving the earnout milestones. The buyer wants flexibility to integrate the acquired business into its existing operations and make strategic decisions without being constrained by earnout considerations.

In healthcare specifically, ordinary course obligations generate complex questions. Can the buyer change the clinical trial protocol? Can it reprioritize the pipeline and delay the earnout-related program? Can it discontinue the program if safety signals emerge? Can it reassign the sales force to other products? These questions require careful drafting that anticipates the specific healthcare scenarios likely to arise during the earnout period.

Healthcare earnout disputes are disproportionately common relative to other sectors, and they tend to involve higher dollar amounts because the contingent payments are larger. Common dispute patterns include:

Buyer interference. The seller alleges the buyer deliberately took actions to avoid achieving the earnout milestone, such as reassigning resources, changing the clinical protocol, or reducing commercial investment in the acquired product. The landmark case is the Sanofi/Genzyme CVR litigation, where Genzyme CVR holders alleged Sanofi under-invested in the acquired products to avoid CVR payments.

Accounting disagreements. In financial earnouts, the parties dispute the calculation of the financial metric. The buyer's interpretation of "net revenue" or "adjusted EBITDA" yields a number below the earnout threshold; the seller's interpretation yields a number above it. These disputes frequently go to arbitration.

Force majeure and regulatory changes. The earnout milestone becomes impossible to achieve due to regulatory changes, pandemic disruptions, or other events outside either party's control. Who bears this risk depends on the contract language, and poorly drafted provisions create ambiguity.

Post-closing integration conflicts. The buyer integrates the acquired company's operations, sales force, or manufacturing into its existing infrastructure in ways that the seller argues undermined the likelihood of earnout achievement. For example, a pharma acquirer merging the target's specialty sales force into a larger generalist team may reduce promotional intensity for the earnout-eligible product, lowering the probability of hitting commercial sales milestones. The seller contends this integration decision violated the buyer's operating obligations; the buyer contends it was a reasonable business decision within its discretion. These disputes are particularly common in healthcare because the acquirer's existing commercial infrastructure (sales representatives, formulary relationships, managed care contracts) is a primary source of channel synergy but also a source of conflict with earnout structures that assume independent operation of the acquired product.

Earnout structures differ meaningfully between biopharma and healthcare services transactions:

A notable trend in biopharma earnout structures is the declining share of upfront cash as a percentage of total deal value. In 2025, upfront payments represented approximately 15% of total deal value across biopharma transactions (down from historical norms of 25-35%), indicating that buyers are increasingly structuring larger portions of total consideration as contingent payments to manage risk. This shift reflects both the patent cliff urgency (which drives buyers to acquire earlier-stage assets where more of the value is speculative) and the competitive dynamics of the M&A supercycle (where earnout potential allows buyers to offer higher headline values while managing downside exposure). For sellers, this trend means that total announced deal values are increasingly aspirational rather than guaranteed, making the probability-weighted expected value of the earnout structure, not just the headline number, the critical metric in evaluating competing bids.

In healthcare services, earnouts are frequently used in physician practice management acquisitions to incentivize physician-owners who remain post-acquisition. The earnout (or rollover equity) ensures the physician stays engaged and maintains patient volumes during the critical transition period. These earnouts tend to be shorter-term (1-2 years) and tied to operational metrics (patient visits, revenue per provider, new patient acquisition).

The next article covers contingent value rights, a specialized form of contingent consideration unique to biopharma that has surged in usage to 27 deals in 2025.