We are structuring an earnout to bridge a valuation gap, but we are terrified the buyer will load up our post-close business unit with corporate overhead allocations that wipe out our EBITDA. How do we negotiate the definition of earnings to protect our earnout from accounting manipulation?

Question

Tyler Smith · Accepted Answer

Never agree to an earnout tied to net income or standard EBITDA unless you have absolute, contractually guaranteed control over the operational expenses of your business unit post-close. Large strategic buyers and private equity sponsors are notorious for allocating corporate overhead, human resources costs, IT licensing, and shared marketing expenses down to the acquired entity, which can artificially depress your operating margin. The cleanest solution is to base the earnout on top-line revenue or, if the buyer objects, on gross profit or gross margin. Gross profit is much harder for their corporate accountants to manipulate because it is tied directly to the cost of goods sold or direct service delivery costs. If the buyer insists on using EBITDA, you must negotiate a detailed schedule of excluded expenses in the purchase agreement. Specify that no parent-company overhead, shared services, or management fees can be allocated to your division for the duration of the earnout period. Additionally, insist that your existing leadership team retains the authority to run the business according to your established EOS V/TO® and budget. If the buyer overrides your operating decisions, hires expensive personnel you did not approve, or redirects your sales team to other products, the earnout must instantly accelerate and pay out at one hundred percent of the target. This protects your hard-earned upside from corporate bureaucracy.