The buyer wants our post-close earnout to be calculated on net income, but they are planning to allocate a corporate overhead fee to our profit and loss statement. How do we negotiate the definition of our earnout metrics in the purchase agreement to prevent their corporate expenses from destroying our payout?

Question

Tyler Smith · Accepted Answer

Do not agree to an earnout based on net income. Net income is too easy for a buyer to manipulate through accounting adjustments, corporate allocations, and shared service fees. When a buyer consolidates operations, they will naturally want to push down a portion of their corporate HR, legal, insurance, and executive salaries to your operating unit. This overhead allocation will immediately suppress your net income and wipe out your earnout.

Instead, insist that the earnout be measured on top-line revenue or a highly defined version of gross profit. If the buyer absolutely insists on an EBITDA-based earnout, you must write strict exclusions into the definition of EBITDA within the purchase agreement.

Negotiate to explicitly exclude any allocated corporate overhead, parent company management fees, or shared services costs that you do not directly control. The agreement should state that EBITDA for earnout purposes will be calculated using the same accounting policies and historical cost structures used during your Quality of Earnings review.

You should also protect your team's operational velocity by retaining control over your headcount. Use your Accountability Chart to define the specific roles necessary to hit the earnout targets. Prevent the buyer from unilaterally cutting key roles or replacing them with centralized corporate staff who do not understand your operational workflows. Define these boundaries in the operational covenants of the purchase contract.