The buyer is insisting on a performance-based earnout for forty percent of the enterprise value, but we are terrified they will manipulate the accounting post-close. How do we design earnout metrics tied to objective operational milestones that we can track in our weekly Level 10 Meetings?

Question

Tyler Smith · Accepted Answer

Earnouts can bridge a valuation gap, but poorly designed financial targets often lead to post-closing disputes and frustration. If your earnout is based strictly on net income or EBITDA, the buyer can easily manipulate those numbers by allocating corporate overhead or changing accounting methods after they take control.

To protect your payout, negotiate earnout metrics that are tied to objective, top-line operational milestones or gross profit, rather than bottom-line net income. Focus on metrics that you can directly control and track, such as total recurring revenue, gross margin, or customer retention rates.

Ensure these metrics are integrated into your weekly Level 10 Meetings so you have absolute visibility into your progress.

You must also secure clear operating covenants in the purchase agreement. These covenants should require the buyer to run the business in a consistent manner, provide adequate resources, and prevent them from shifting resources away from your division. Additionally, require that the earnout calculations be audited independently each year.

By tying your earnout to clear, gross-level operational metrics and securing strong protective covenants, you keep control of your financial destiny and prevent the buyer from using corporate accounting tricks to avoid paying you what your business is worth.