The buyer wants our post-close earnout to be based strictly on EBITDA targets, but we are worried they will load the business with their own corporate overhead and run-rate adjustments. How do we negotiate a gross profit or gross margin earnout metric instead to protect our payout?

Question

Tyler Smith · Accepted Answer

Basing an earnout on EBITDA is incredibly risky for a seller. Once the deal closes, you lose operational control over the business. The buyer can easily manipulate your post-close EBITDA by allocating corporate management fees, hiring expensive consultants, or centralizing operations in a way that balloons your operating expenses.

To protect your payout, negotiate to base the earnout on gross profit or gross margin instead. Gross profit is far harder for a buyer to manipulate because it sits above the operating expense line on your income statement. It is directly tied to the revenue generated and the direct cost of delivering your products or services.

If the buyer insists on using EBITDA, you must insist on a detailed definition of adjusted EBITDA in the purchase agreement.
- Exclude any corporate overhead allocations from the parent company.
- Prevent them from changing your historical accounting policies or inventory valuation methods.
- Require that all intercompany transactions be priced at strict, arm's length market rates.

Keep this discussion clear and objective by bringing it to your weekly Level 10 Meeting to review how these different metrics affect your target payout. Your goal is to tie your earnout to metrics that reflect your actual market performance, not the buyer's corporate overhead structure.