The buyer is proposing an earnout structured on gross margin percentage rather than EBITDA to prevent overhead allocation fights. How do we protect ourselves against them changing our product mix or pricing strategy?

Question

Tyler Smith · Accepted Answer

An earnout tied to gross margin percentage is a favorite tactic for buyers who want to avoid arguments over corporate overhead allocations, but it exposes you to massive risk. If the buyer changes your pricing, alters your product mix, or runs a sloppy supply chain post-close, your gross margins will collapse, wiping out your payout. To protect yourself, you must negotiate strict operational covenants. First, insert a clause that requires the buyer to maintain your historical pricing models and product mix unless you mutually agree otherwise. If they decide to discount your core offering to cross-sell their own services, the earnout calculation must be adjusted to reflect your historical margins. Second, define cost of goods sold with absolute precision. Ensure that no corporate overhead, shared IT systems, or centralized management costs are allocated to your cost of goods sold. Third, use your EOS operating system to maintain control over the delivery. Ensure your Accountability Chart remains intact post-close, with you or your designated Integrator retaining the authority to hire, fire, and manage the delivery team. If the buyer can bypass your team or alter your operational processes, they can easily destroy the margin you are working to hit. Keep the operating model locked down in the legal agreement to ensure you actually get paid.