A private equity buyer wants an earnout based on gross revenue growth, but they plan to cross-sell our products into their portfolio companies at discounted intercompany transfer prices. How do we protect earnout metrics from transfer pricing manipulation and intercompany discounts?

Question

Tyler Smith · Accepted Answer

Revenue-based earnouts seem safer than EBITDA earnouts, but aggressive buyers can manipulate gross revenue through discounted affiliate cross-selling and internal transfer pricing. If the buyer sells your product at a forty percent discount to a sister portfolio company to boost that entity's margins, your earnout calculations absorb the damage while the private equity sponsor wins overall.

To insulate your earnout against affiliate manipulation, write strict intercompany transfer pricing covenants into the definitive purchase agreement. The contract must mandate that all intercompany sales or affiliate cross-selling are recorded at standard fair market value list prices, regardless of any internal discounting the buyer applies for their own accounting convenience.

Furthermore, require standalone revenue tracking. Specify that your products must be invoiced on separate customer line items with independent pricing verification, rather than bundled into omnibus enterprise contracts where your software or service is used as a zero-margin loss leader to close larger sponsor deals.

Finally, secure unilateral audit rights and mandate a binding dispute mechanism. You must retain the right to inspect sales ledgers quarterly, with the buyer paying for an independent accounting referee if an earnout discrepancy exceeds three percent. In your transition period, ensure your sales leader on the Accountability Chart retains operational sign-off on product pricing so the buyer cannot alter commercial terms without your consent.