The buyer insists that our earnout be pegged to EBITDA rather than top-line revenue, but we will not control operational overhead post-close. How do we negotiate a gross profit earnout that protects both parties?

Question

Tyler Smith · Accepted Answer

Pegging an earnout to EBITDA is the most common trap founders walk into. Once you hand over the keys, the buyer controls the P&L below the gross margin line. They can allocate corporate overhead, hire redundant executives, ramp up administrative expenses, or launch aggressive marketing campaigns that crush EBITDA while expanding their long-term enterprise value at your expense.

Revenue earnouts present the opposite problem. Buyers hate them because you could discount prices or burn marketing cash just to hit top-line targets without delivering profits.

Gross profit is the correct middle ground. It forces you to deliver profitable work while preventing the buyer from burying the earnout under corporate allocations or administrative bloat.

To structure a gross profit earnout cleanly, you must define the calculation with absolute specificity in the purchase agreement. Establish clear rules for Cost of Goods Sold. Fix the labor burden rates, define direct materials pricing, and exclude any shared service overhead allocations from the buyer parent entity.

Additionally, build in operating covenants that protect the pipeline. The buyer must agree to maintain historical marketing budgets, support current sales capacity, and avoid altering credit terms that could throttle customer volume.

If the buyer insists on EBITDA, require an operational standstill where your leadership team retains complete GWC authority over headcount and overhead spending for the earnout period. If you do not have operational control, do not sign an EBITDA earnout.