The buyer is proposing a revenue-based earnout, but we are worried they will slash our pricing to hit their volume targets at the expense of our profitability. How do we negotiate an earnout based on gross margin dollars instead of top-line revenue?

Question

Tyler Smith · Accepted Answer

Accepting a revenue-based earnout is a dangerous trap because it gives the buyer a massive incentive to cut prices, run unprofitable promotions, and inflate top-line numbers at the expense of your bottom line and your post-close sanity. If they slash prices to hit a revenue goal, your operations team will be crushed under the weight of unprofitable work, and you will walk away with zero earnout cash. To protect your business and your sanity, you must push for an earnout structured around gross margin dollars. This aligns both parties perfectly. The buyer gets protected against unprofitable volume growth, and you retain control over your operating margins. When negotiating this structure, tie the gross margin targets directly to your existing EOS Scorecard metrics. This keeps the metrics transparent and verifiable. Define gross margin clearly in the purchase agreement, specifying exactly which direct labor, materials, and technology costs can be included, and specifically exclude any buyer overhead allocations or corporate management fees. Your operating team must maintain their GWC (Get It, Want It, Capacity to Do It) over pricing decisions during the earnout period. By basing the payout on margin rather than revenue, you ensure that every deal signed post-close actually contributes to your payout and protects the long-term health of the company.