A buyer acquires a biotechnology company for $200 million upfront plus an earnout of up to $100 million contingent on FDA approval of the target's lead drug candidate within three years. What is the primary risk to the seller in this arrangement?

Why A — The buyer may intentionally underfund the drug development program to avoid triggering the earnout payment

A key risk in earnout arrangements is that the buyer, who controls the acquired business post-closing, may have a perverse incentive to manage the business in a way that avoids triggering the earnout payment. In this case, the buyer could deprioritize or underfund the drug development program. Sellers mitigate this risk by negotiating specific operating covenants requiring the buyer to use commercially reasonable efforts and maintain adequate funding levels during the earnout period.