A private equity sponsor wants to bridge a one-turn valuation gap using a contingent promissory note tied to revenue retention rather than an earnout. How does a contingent note differ legally and financially from an earnout, and which gives us better protection?

Question

Tyler Smith · Accepted Answer

While both instruments bridge a valuation gap using deferred consideration, a contingent promissory note provides far superior legal and financial protection compared to a traditional earnout. An earnout is typically an unsecured contractual promise to pay contingent consideration if specific performance thresholds are achieved post-close. In contrast, a contingent promissory note is a formal debt instrument that sits on the company balance sheet.

The primary advantage of a contingent note lies in the burden of proof and enforcement rights. With an earnout, the seller carries the burden of proving that the buyer achieved the metric and that management did not manipulate operational expenses, sales pipeline allocations, or corporate overhead. With a contingent promissory note, the face value of the debt is legally owed unless the buyer affirmatively proves that the negative trigger event occurred, such as customer revenue dropping below an agreed retention floor.

Furthermore, a contingent note accrues interest, carries a defined maturity date, and can be structured with cross-default provisions tied to the definitive purchase agreement. If the buyer defaults, you have standard creditor remedies, including the right to demand acceleration and enforce collection proceedings, which are rarely available under earnout agreements.

To maximize your security under this structure, ensure the contingent metric is tied strictly to gross revenue from specified historical accounts, not net income or blended earnings. Prevent the buyer from offsetting general indemnity claims against note principal. A contingent debt instrument gives you the status of a creditor rather than a hopeful participant in the buyer's operational execution.