The buyer is structuring thirty percent of our purchase price as a post-close earn-out tied to net income, but they plan to allocate corporate overhead charges to our division. How do we structure our post-close operating covenants to protect our earn-out from being wiped out by their corporate costs?

Question

Tyler Smith · Accepted Answer

Tying an earn-out to net income is highly risky because a buyer can easily reduce your division's net profitability by allocating centralized corporate overhead charges, such as executive salaries, IT services, or legal fees, to your books. To protect your earn-out, you must negotiate strict post-close operating covenants in the purchase agreement. First, demand that the earn-out be calculated on revenue or gross profit rather than net income or EBITDA. Gross profit is far harder for a buyer to manipulate through accounting adjustments. If the buyer absolutely insists on an EBITDA-based earn-out, you must write explicit exclusions into the legal agreements. Specify that no parent company corporate overhead, management fees, or shared services allocations can be charged to your operating unit for the duration of the earn-out period. Ensure your business unit continues to operate as a standalone division, and use your existing Accountability Chart to define exactly which resources your team will control. Write covenants that guarantee you maintain authority over your operational budget, hiring decisions, and capital expenditures. By protecting your operational autonomy and excluding centralized corporate costs from your financial metrics, you ensure that your ability to hit your earn-out targets remains entirely within your team's control.