The buyer is offering a high headline valuation but structures thirty percent of it as an EBITDA-based earn-out. How do we structure the accounting definitions in our purchase agreement to prevent the buyer from allocating corporate overhead or shared services to our operating unit and wiping out our earn-out?

Question

Tyler Smith · Accepted Answer

A post-close earn-out tied to EBITDA is highly risky if the accounting definitions in the purchase agreement are vague. Once the transaction closes, the buyer will integrate your operations. They may start allocating their parent-level corporate overhead, centralized marketing costs, and corporate legal fees to your operating unit's profit and loss statement. These allocations will quickly wipe out your operating margins and destroy your chances of hitting your earn-out targets.

To protect your earn-out, you must negotiate a strict, customized definition of EBITDA in the definitive agreement. The agreement must state that your business unit will be evaluated on a stand-alone basis, using the same accounting policies and historical practices you used before the sale. Explicitly exclude any allocated corporate overhead, parent-level management fees, or shared services costs from the calculation.

Additionally, you must secure operational covenants that guarantee you have the resources, headcount, and budget required to hit the targets. Use your quarterly Rocks to monitor your operational capacity leading up to the sale. If you do not lock down these protective accounting definitions and resource guarantees before you sign, your earn-out is nothing more than a paper promise that the buyer can easily manipulate.