The buyer is offering our target valuation but wants to structure twenty percent of it as an earnout based on Net Income. How do we protect ourselves from post-close corporate overhead allocations that could wipe out our payout?

Question

Tyler Smith · Accepted Answer

Accepting an earnout based on Net Income is an incredibly risky move that you should resist. Once you sell, you lose operational control, and the new owner can easily wipe out your Net Income through corporate overhead allocations, transfer pricing, and aggressive post-close investments. To protect your payout, you must refuse Net Income as the target metric. Instead, insist on basing the earnout on Gross Profit or Gross Revenue. These top-line metrics are much harder for a buyer to manipulate through accounting adjustments. If the buyer absolutely insists on an earnings-based metric, you must negotiate a strict definition of Adjusted EBITDA specifically for the earnout calculation. This definition must explicitly exclude any corporate overhead allocations, management fees, parent company debt service, or integration costs. You must also secure operational covenants in the purchase agreement. These covenants should guarantee that your business unit will be run as a separate division with its own dedicated resources, and that you will maintain the authority to manage your team and execute your strategy. Use your V/TO® and clear Accountability Chart structures to define how the business unit must be operated post-close. If they refuse to grant these protections, you are better off taking a lower upfront purchase price rather than chasing an earnout that the buyer can easily manipulate to zero.