The buyer is requiring an earnout based on gross margin milestones, but we are worried they will cut our marketing budget or restrict hiring key personnel post-close. How do we structure operational covenants to protect our earnout metrics?

Question

Tyler Smith · Accepted Answer

An earnout tied to financial performance without operational guardrails is a deferred purchase price reduction. When a buyer assumes control, their financial priorities change. They may redirect leads to higher-margin acquisitions, institute parent-company hiring freezes, or slash advertising to hit their own short-term targets. If your earnout depends on gross margin or revenue, you must legally protect your ability to hit the numbers.

Structure affirmative and negative operating covenants directly inside the purchase agreement. These covenants should include:
- A committed minimum quarterly operating budget for sales, marketing, and technology maintenance that cannot be reduced without your written consent.
- Defined hiring autonomy to fill open seats on your Accountability Chart up to budgeted compensation thresholds without parent-level approvals.
- A covenant requiring the buyer to operate the business in the ordinary course of business, consistent with historical practices, and prohibiting discretionary corporate cost allocations from hitting your gross profit lines.
- An acceleration clause stating that if the buyer breaches an operating covenant, terminates your key leaders without cause, or sells the division, the entire remaining earnout balance accelerates and becomes immediately due in full.

Never accept a provision giving the buyer sole operational discretion. Build your target metrics around operational milestones you directly control, and make the failure to support those milestones a default event.