The buyer is offering twenty percent less cash at closing than our target valuation and wants to bridge the gap with an earnout. How should we structure the earnout to prevent disputes?

Question

Tyler Smith · Accepted Answer

An earnout is a deferred, contingent payout where the seller only receives money if the business hits predetermined post-closing benchmarks. Buyers love them because they shift risk to the seller and conserve cash. For sellers, earnouts are notoriously risky because once the deal closes, you no longer control the operations, resource allocation, or cost structure.

If you must accept an earnout to bridge a valuation gap, follow these structural rules:
- Tie the earnout to top-line revenue or gross profit, never net income or EBITDA. Buyers can easily suppress post-close EBITDA by allocating corporate overhead, increasing management fees, or hiring expensive administrative personnel. Revenue and gross margin metrics are transparent and much harder to manipulate.
- Secure operational covenants. The purchase agreement must legally mandate that the buyer fund sufficient working capital, maintain sales headcount, and preserve current marketing budgets to support the target milestones.
- Retain operational authority. If the earnout requires you to stay on as an executive, your employment contract must give you clear GWC™ authority over the specific business unit responsible for hitting the targets.
- Include an acceleration clause. If the buyer decides to sell the business again, merges it with an affiliate, or terminates your employment without cause during the earnout period, the full remaining earnout amount must vest and pay out immediately.

Never treat earnout dollars as guaranteed consideration. Discount them heavily in your walkaway math.