The buy-side due diligence team identified a customer concentration risk and is proposing a sliding-scale earnout where our payout is tied directly to the retention of our top three accounts. How do we structure a performance-based floor to protect our valuation?

Question

Tyler Smith · Accepted Answer

Customer concentration is a common valuation killer, and buyers will routinely use it to push as much risk as possible back onto the seller through conditional earnouts. If you must accept a sliding-scale earnout tied to your top three accounts, you must build a structure that protects you from factors outside your control. First, negotiate a baseline performance floor. If these key customers maintain at least eighty percent of their historic purchasing volume, you should receive one hundred percent of that portion of the earnout. Do not agree to a linear drop where a minor five percent dip in their spending leads to a five percent drop in your payout. Second, define exactly what constitutes a customer loss. If a customer reduces their spend because the buyer changes the product quality, raises prices, or fails to service the account post-close, that cannot count against your earnout. You must include clear carve-outs in the purchase agreement stating that any decline in revenue from these accounts due to the buyer's post-closing operational changes or failure to perform will be treated as if the customer remained at one hundred percent capacity. In your V/TO®, you plan for long-term growth, and the buyer is buying that vision. If they mismanage the key relationships after you step away from the daily operations, you should not pay the price.