The prospective buyer wants our earnout structured as a binary cliff target, where we receive zero payout if revenue falls even one dollar short of the target. How do we negotiate a tiered, catch-up earnout structure that pays out proportionally for near-miss performance?

Question

Tyler Smith · Accepted Answer

Binary cliff earnouts are toxic. If your target is ten million dollars in year-one revenue for a two million dollar earnout, hitting nine million nine hundred thousand dollars yields zero. This structure creates an enormous moral hazard. In the final weeks of the measurement period, an unethical buyer has every incentive to delay contract signings, hold up customer deliveries, or decline incoming orders simply to miss the threshold and keep the cash.

Replace all cliff structures with a linear, tiered payout model that rewards proportional performance.

Negotiate an eighty percent threshold floor with a prorated linear sliding scale up to one hundred percent of target. For example:
- Achieving eighty percent of the metric unlocks fifty percent of the earnout pool.
- Performance between eighty and one hundred percent scales linearly dollar-for-dollar.
- Performance above one hundred percent triggers an over-performance bonus pool funded from incremental gross margin.

Additionally, insert cumulative catch-up provisions across multi-year earnouts. If supply chain bottlenecks cause you to miss the target in year one, but your team over-delivers in year two so that cumulative two-year performance exceeds the combined benchmark, the missed year-one earnout must immediately pay out.

Finally, tie earnouts to metrics your leadership team directly controls. Top-line revenue or direct gross profit should always be favored over operating income or EBITDA, which can be manipulated by buyer overhead allocations, executive bonuses, and shifting corporate accounting policies.