The buyer is offering our target enterprise value but insists on structuring forty percent of the purchase price as an earnout. How do we negotiate the operational covenants to protect our payout?

Question

Tyler Smith · Accepted Answer

When forty percent of your purchase price is structured as an earnout, you are essentially partnering with the buyer post-close, which means you must protect yourself from their operational interference. If the earnout is tied to future EBITDA targets, the buyer can easily manipulate your payout by allocating corporate overhead, hiring expensive personnel, or changing your pricing structure. To protect your payout, negotiate to have the earnout tied to gross revenue or gross profit rather than EBITDA. Gross metrics are much harder for a buyer's corporate accounting team to manipulate through internal allocations. If the buyer absolutely insists on an EBITDA metric, you must write strict operational covenants into the definitive agreement. These covenants must grant you operational control over the business unit during the earnout period. Specifically, secure veto rights over any changes to your budget, hiring decisions, and pricing strategies. Use your V/TO to outline the strategic plan for the earnout period, and get the buyer to sign off on this operating plan as an exhibit to the purchase agreement. Additionally, establish a clear dispute resolution mechanism that utilizes an independent accountant to review any post-close financial adjustments. Ensuring your leadership team maintains the authority to execute their quarterly Rocks without corporate interference is the only way to guarantee you actually receive your earnout.