We are negotiating an earnout based on recognized revenue, but the buyer uses different GAAP accounting policies that defer revenue recognition longer than our current system. How do we write a consistent accounting standards clause into the purchase agreement to prevent the buyer's accounting team from shrinking our earnout payments?

Question

Tyler Smith · Accepted Answer

When you agree to an earnout, you are at the mercy of how the buyer calculates your financial performance post-closing. If the buyer uses different GAAP accounting methods, they can shift the timing of your revenue recognition, making it look like you missed your earnout targets even if your operations are performing exceptionally well. This is a common tactic used to reduce payout amounts.

To prevent this, you must write a strict consistent accounting standards clause into your purchase agreement. This clause must dictate that for the purposes of calculating your earnout, revenue and expenses must be calculated using the exact same accounting principles, practices, and methodologies that your business used prior to the closing.

Do not rely on a generic GAAP clause. GAAP allows for significant flexibility and interpretation, especially regarding revenue recognition for multi-year contracts or software-enabled services. Specify that your historical practices take precedence over any changes the buyer's corporate accounting team tries to implement.

Additionally, require the buyer to maintain separate, standalone books for your business unit during the earnout period. This ensures that your revenue is not commingled with their other entities, allowing you to audit the calculations easily and protect your hard-earned payout.