The buyer is proposing a two-year revenue earnout to bridge our valuation gap, but we are concerned they will starve the business of working capital or redirect sales pipeline. What operational covenants and protective terms must we demand?

Question

Tyler Smith · Accepted Answer

When you agree to an earnout, you effectively become an unsecured lender whose repayment depends on the buyer's post-closing management decisions. To ensure an earnout is achievable, the definitive purchase agreement must contain explicit operating covenants and negative controls that bind the buyer during the entire earnout period.

First, mandate an affirmative covenant requiring the buyer to operate the business in the ordinary course, consistent with past practice. This must include minimum commitments for marketing spend, inventory levels, working capital support, and headcount. If the buyer cuts operational capacity, they artificially cap revenue and kill your payout.

Second, secure anti-diversion covenants. The agreement must state that the buyer cannot divert sales leads, existing clients, or commercial opportunities from your legacy company to their other operating entities. Any revenue generated from your customer base, even through cross-selling of the buyer's broader product portfolio, must count toward your earnout hurdle.

Third, establish operational autonomy or board observation rights. If you or your Integrator remain post-close, maintain veto rights over changes to sales compensation, pricing matrices, and territory allocations. If you depart, negotiate an acceleration clause: if the buyer cuts operational investment below agreed thresholds, breaches operating covenants, or sells the division, the remaining earnout vests immediately at 100 percent of maximum value. Without these contractual teeth, you are gambling on the buyer's goodwill.