Earnouts and Escrow: Why the Headline Is Not the Price

The headline is a ceiling, not a price

An announced consideration is usually four things. Cash at close. An adjustment measured after close for cash, debt and working capital against an agreed target. An amount in escrow against warranty claims. And an earnout, contingent on the business doing something it has not done yet. Only the first is money you have.

Two things sit on top. The preference stack decides the order of payment before anything is divided, which belongs to liquidation preference. And where the fully diluted count used to set price per share includes the option pool, options cashed out or rolled come out of that same total, and are taxed in the holder’s hands. Brief your team before the announcement: how ESOPs work.

How an earnout is actually built

Five parts get negotiated separately: the metric, the measurement period, the target, the slope between floor and cap, and the payment mechanism. The metric decides who can move it. Revenue is easy to verify and easy to influence, because a buyer that reprices, shifts channel mix or routes volume to a sister entity changes your number without doing anything improper. A profit metric moves the argument to cost: inside a group, a management fee, a shared warehouse charge and a transfer price on a common input are real costs somebody else now chooses.

The slope matters more than founders expect. One all-or-nothing threshold turns a two percent miss into a total loss and a dispute. A tiered scale between a floor and a cap turns it into arithmetic, so ask for the scale even if the cap comes down in exchange. Be careful with any range presented as standard: there is no reliable published benchmark for how much of an Indian direct-to-consumer deal is typically held back, and published figures cover other markets.

Escrow, and the cap that fixes its shape

Escrow is not the earnout. The earnout is more money if the business performs; escrow is money already agreed, held back in case something you promised turns out to be untrue. It secures the warranties in the sale agreement, specific indemnities for risks diligence already found, and any post-close adjustment. What you argue over is the release schedule, whether escrow is your sole recourse, the thresholds below which no claim can be brought, and how long each warranty survives.

Cross-border, rule fixes the shape. Rule 9(6) of the Foreign Exchange Management (Non-debt Instruments) Rules, 2019, in force from 17 October 2019, allows not more than twenty five percent of the total consideration on a transfer of equity instruments between a resident and a non-resident to be paid on a deferred basis within eighteen months of the transfer agreement, or settled through escrow for up to eighteen months from that agreement, or indemnified by the seller for up to eighteen months from the date the buyer pays the full consideration.

A foreign buyer therefore cannot hold a third of your price for three years as a matter of course, and Majmudar and Partners, writing on these limits, reports that in its experience approval has not been granted above them. A domestic deal between two residents is not under this rule, which is why an Indian strategic buyer can propose a longer, larger holdback.

Lock-in, and what leaving early costs

Three things get called lock-in, and they bind very differently. The employment or consultancy agreement has a term and a notice period. It is the weakest: nobody is going to make you work.

The restrictive covenants sit in the sale documents and last longer. Section 27 of the Indian Contract Act, 1872 makes an agreement restraining anyone from exercising a lawful profession, trade or business void to that extent. Its own exception lets a person who sells the goodwill of a business agree not to carry on a similar business within local limits the court finds reasonable, while the buyer carries on a like business there. So a founder selling is not in an employee’s position, but how far that exception reaches a share sale is an argument, not a given. Watch the pricing of the covenant too, because Section 28(va) of the Income-tax Act, 1961 treats a sum received for not carrying out an activity in relation to a business as business income, subject to exceptions.

The third is the one that actually holds you: money not yet paid, tied to your continued presence. Unpaid earnout instalments, rollover equity still unvested, a clawback that accelerates on departure. The mechanism is a good leaver and bad leaver definition, and the question is which one a resignation makes you, and who decides. So negotiate that the earnout survives a termination without cause, that a partial period is pro-rated, and that cause is narrow and objective.

The traps are in the definition and the levers

An earnout dispute is almost never about arithmetic. It is about a definition buried in a schedule, and a decision taken by somebody who now saves money if you miss. Define the metric to a named accounting policy and a named source system, and attach a worked calculation on last year’s actuals. Revenue left undefined gets defined by the buyer.

Then guard the perimeter. Your listings may be merged into the parent’s marketplace accounts, your site folded into theirs, your customers served through a group app. Each can be sensible and each destroys the measurement, so ask for the earnout business to be a standalone reporting unit for the period, with a written definition of what belongs inside it, and cap group charges if the metric is a profit line.

What to negotiate hardest

In order. Cash at close, the only figure that is not a forecast. The metric and its definition. The standalone reporting unit. The committed budget, because a target needing inventory or media needs approval from people who pay when you succeed. The leaver terms. Escrow as sole recourse, capped, with thresholds and a staged release. Then the governance: inspection rights, a fixed objection window, an independent expert as tie breaker. And ask who owes you: an earnout is a claim on whichever entity signed.

ITC and Sproutlife Foods shows how long these tails run. Binding documents came in January 2023, with the balance stake to be acquired on pre-defined valuation criteria, and completion came on 28 September 2026. A formula agreed at one board meeting shaped a price paid three and a half years later. Not legal or tax advice. Have an Indian deal lawyer and a tax adviser read the sale agreement, the escrow agreement and your employment agreement together.