A private equity buyer agrees on our target enterprise value but wants twenty-five percent of the purchase price structured as an earnout and ten percent as a seller note. How should we evaluate and negotiate these non-cash deal components so we do not end up giving away our company for fifty cents on the dollar?

Question

Tyler Smith · Accepted Answer

A headline valuation is vanity; cash at close is sanity. Buyers frequently offer an inflated enterprise value to win an LOI, only to structure thirty to forty percent of that figure into unsecured, contingent liabilities. An earnout is essentially an interest-free loan you grant to the buyer where you bear all the operational risk and they retain total operational control.

If you must accept an earnout to bridge a valuation gap, never tie it to net income or EBITDA. Post-close, the buyer can bury your profitability under management fees, allocated corporate overhead, corporate travel, and aggressive hiring plans. Tie earnout metrics exclusively to top-line gross revenue or gross margin dollars produced by specific service lines that you directly control.

Demand operational covenants in the purchase agreement that require the buyer to maintain adequate working capital, preserve your sales budget, and prevent them from redirecting your delivery staff to other portfolio companies. If they breach those operational covenants, the full earnout must accelerate and become immediately due in cash.

For the seller note, treat it like an institutional commercial loan. It must carry a market-rate coupon of eight to twelve percent, have a defined maturity date of three to five years, and be backed by personal guarantees or secondary liens on company assets. Ensure the subordination agreement with the buyer's senior bank lender allows ongoing interest payments as long as the company maintains standard debt coverage ratios. If the buyer refuses these terms, their headline valuation is an illusion.