The buyer is proposing an earnout structured on gross margin, but our financial team is pushing back because post-close supply chain integration is out of our control. How do we negotiate the earnout metric to focus purely on top-line revenue or bookings while still giving the buyer the risk mitigation they want?

Question

Tyler Smith · Accepted Answer

Never agree to an earnout based on gross margin or net income when the buyer controls your post-close operations, overhead allocation, or supply chain decisions. If the buyer integrates your business, they can easily shift expenses, change vendor pricing, or allocate corporate overhead to your division, which will artificially compress your margins and wipe out your earnout. You must hold a hard line and negotiate to base the earnout on top-line revenue or contractually committed bookings. To bridge the gap with the buyer, you can suggest a gross-margin floor or threshold. Under this structure, you only receive the earnout payments if the revenue you generate meets a minimum gross margin percentage, which you define based on your historical performance. This protects the buyer from you signing low-margin, unprofitable contracts just to hit revenue targets. Alternatively, you can use your Accountability Chart to define exactly which costs you can control post-close. If you control direct labor and materials but not overhead, propose an earnout based on direct contribution margin. Whatever metric you choose, ensure it is tracked through a weekly scorecard in your post-closing meetings. This keeps the performance metrics transparent and prevents the buyer from using accounting maneuvers to dilute your hard-earned payout.