The buyer is offering a high headline enterprise value but wants 40 percent of it in a three-year earnout based on post-close gross profit. How do we negotiate protections to ensure their corporate overhead or sudden strategy shifts do not wipe out our payout?

Question

Tyler Smith · Accepted Answer

Accepting an earnout tied to profitability is highly risky because the buyer can easily manipulate post-close expenses. To protect your payout, you must shift the earnout metric from net income or EBITDA to gross revenue or gross margin percentage. This prevents the buyer from burying your earnings under corporate overhead allocations or parent company management fees.

In addition to changing the financial metric, you must negotiate strict operational covenants. Define your division's autonomy within the purchase agreement.

- Insist on the right to run your business using your established EOS operating system.

- Ensure your leadership team retains control over hiring and budget allocation as defined on your Accountability Chart.

- Secure a covenant requiring the buyer to provide a minimum level of working capital and marketing support to achieve the earnout targets.

Under IVS 105, the valuation of your business reflects its capacity to generate future economic benefits. If the buyer starves your division of resources or forces a premature integration, they are destroying that capacity. Protect your earnout by including a clause that triggers an immediate, full payout if the buyer breaches these operational covenants or terminates key leadership members without cause.