If we have to accept an earnout to achieve our target enterprise value, what specific operating covenants and legal protections must we negotiate to prevent the buyer from manipulating the payout?

Question

Tyler Smith · Accepted Answer

An earnout without strict operational covenants is merely a phantom headline price. Once closing occurs, the buyer controls the operational levers. If they make poor strategic decisions, load the business with administrative overhead, or mismanage your former staff, your earnout proceeds can evaporate quickly.

To protect yourself, negotiate four non-negotiable provisions in the definitive purchase agreement:

- Accounting consistency: Mandate that earnout metrics are calculated strictly according to GAAP, applied on a basis consistent with your historical pre-close accounting practices. Explicitly exclude corporate allocations, parent company management fees, transaction-related legal or advisory expenses, and post-close synergy costs.

- Operational covenants: Require the buyer to operate the business in the ordinary course of business. Prohibit them from redirecting sales leads to other corporate subsidiaries, artificially delaying product shipments to depress current-period earnings, or altering customer credit terms without your written consent.

- Resource commitments: If the earnout target requires revenue growth, bind the buyer contractually to maintain minimum marketing budgets, inventory working capital, and headcount staffing levels.

- Acceleration on change of control or breach: Require that all remaining earnout payments accelerate immediately and become payable in full if the buyer resells the business, terminates your employment without cause, or breaches any material operational covenant.

If the buyer refuses to grant comprehensive operational protections and audit rights, reject the earnout structure entirely and adjust the closing cash consideration.