The buyer wants a three-year earnout tied to gross margin expansion on our newest product line, but they plan to control product pricing and future capital allocation. How do we negotiate operational covenants so buyer decisions do not wipe out our earnout?

Question

Tyler Smith · Accepted Answer

Accepting an earnout where the acquirer retains unfettered operational control over the underlying metrics is effectively giving away your enterprise value. When targets are tied to product-level gross margins, post-close decisions around discounting, marketing spend, supply chain vendor changes, and research allocations directly impact whether you ever see that earnout capital.

To protect your proceeds, embed clear operational and accounting covenants into the purchase agreement:

- Define gross margin under GAAP using fixed, pre-closing accounting methodologies that explicitly bar the allocation of buyer corporate overhead, shared IT systems, or acquisition amortization into cost of goods sold.
- Retain operational authority over pricing floors, key product hires, and marketing budgets through your designated post-closing leadership role on the business unit Accountability Chart.
- Require the buyer to commit to a mandatory annual capital expenditure floor dedicated to that product line, preventing them from starving the business unit of resources.
- Include an audit right that gives your independent CPA full access to raw enterprise resource planning data within thirty days of each calculation period, with the buyer paying audit fees if calculations are understated by more than five percent.
- Add an immediate acceleration clause stating that if the buyer alters corporate strategy, discontinues the product line, reassigns core personnel, or sells the division to another entity, the remaining earnout balance becomes fully earned and payable within ten business days.

Earnouts should bridge genuine valuation discrepancies around future execution, not subsidize a buyer's post-closing corporate experimentation at your expense. If the buyer refuses basic operational covenants and capital commitments, walk away from the earnout and trade it for a smaller, guaranteed seller note.