The buyer plans to integrate our back-office operations into theirs post-close but wants our earnout calculated on our division's net income. How do we prevent them from allocating corporate overhead to our ledger and wiping out our payout?

Question

Tyler Smith · Accepted Answer

Calculating an earnout on net income or EBITDA gives the buyer too many opportunities to manipulate the numbers through corporate allocations. When a buyer consolidates operations, they often load the acquired company with parent-level overhead charges, such as corporate legal fees, shared IT services, and executive salaries.

The best defense is to base the earnout on gross profit or net revenue instead of net income. If the buyer insists on a net income metric, you must negotiate strict accounting rules in the purchase agreement. Define exactly what expenses can be charged to your business unit post-close.

Specify that any shared services or corporate overhead must be allocated at actual cost without any markup, and only if those services directly benefit your division. Additionally, establish a cap on corporate allocations, limiting them to a fixed percentage of your revenue.

Use your Accountability Chart to isolate your division's operational expenses. Keep your local leadership team in control of your direct operating expenses, and require the buyer to maintain a separate set of books for your business unit. This ensures you can verify every line item during the earnout period and prevent accounting tricks from eroding your hard-earned value.