The buyer is proposing a $3 million earnout based on achieving post-close EBITDA targets, but we are concerned about their ability to manipulate corporate overhead allocations. How do we negotiate the earnout metric to run on gross revenue or contribution margin instead of bottom-line EBITDA?

Question

Tyler Smith · Accepted Answer

Never accept an earnout based on bottom-line net income or standard EBITDA if you do not retain absolute, unfettered operational control over post-closing accounting decisions. Once the transaction closes, a buyer can easily compress EBITDA by allocating shared corporate overhead, funding unbudgeted corporate management fees, accelerating research and development expenses, or hiring expensive enterprise executives whose salaries hit your operating expenses.

Counter immediately by moving the earnout metric up the profit and loss statement to either gross revenue, adjusted gross profit, or direct contribution margin. Gross profit is the most defensible compromise. It aligns both parties: the buyer is protected against you buying unprofitable top-line revenue, and you are protected against the buyer bloating overhead or reallocating administrative expenses to sabotage your payout threshold.

If the buyer refuses to budge from an EBITDA earnout metric, you must build strict covenant protections into the definitive purchase agreement:

- The business must be run as a standalone operating division with separate accounting ledgers throughout the earnout period.
- Corporate overhead allocations, parent management fees, and shared service charges must be explicitly capped or excluded entirely from the calculation.
- Any buyer-mandated salary increases, severance costs, or integration expenses must be added back as normalizations.
- You must retain operational authority over the sales strategy and the Accountability Chart seats that drive performance.

If the buyer will not accept an objective, unmanipulated metric, walk away from the earnout. Roll the consideration into an interest-bearing seller note or adjust the upfront enterprise value.