The buyer is proposing a deal where thirty-five percent of our enterprise value is tied up in a three-year earnout based on achieving aggressive EBITDA targets, but we are worried their corporate overhead charges will destroy our profitability. How do we structure the operational covenants to protect our earnout payout?

Question

Tyler Smith · Accepted Answer

Never agree to an earnout based on EBITDA or net income without strict protection covenants. Buyers can easily manipulate net profitability by allocating corporate overhead, charging management fees, or redirecting your key resources to other portfolio companies. If you must accept an earnout, you must control the metrics and the operational environment.

First, shift the earnout metric from EBITDA to gross profit or top-line revenue. Gross profit is much harder for a buyer to manipulate through accounting adjustments. If the buyer absolutely insists on EBITDA, negotiate a strict definition of adjusted M&A EBITDA that specifically excludes all parent company overhead, corporate management fees, and integration costs.

Second, secure operational covenants in the definitive agreement. You must maintain GWC™, meaning get it, want it, and have the capacity to do it, over your business unit. Use your EOS Accountability Chart to define your operational independence. The agreement should state that you have the sole authority to hire and fire staff, allocate marketing budgets, and execute your quarterly Rocks without parent company interference.

Finally, include an acceleration clause. If the buyer terminates your leadership team without cause, changes your core product offering, or fails to fund the working capital budget agreed upon in your V/TO®, the entire earnout must immediately vest and become payable. This ensures the buyer cannot starve your operation to avoid paying you your hard-earned proceeds.