The buyer wants to tie a third of our enterprise value to a post-close gross profit earnout, but we are worried about their post-close pricing strategy killing our margins. How do we structure protective operational covenants or a floor on the earnout to prevent them from mismanaging our legacy client base?

Question

Tyler Smith · Accepted Answer

Agreeing to an earnout based on gross profit or EBITDA is a major risk if the buyer gains complete control over your pricing and operational costs post-close. If they slash prices to win volume, or if they allocate excessive corporate overhead to your business unit, your earnout could quickly drop to zero.

To protect your capital, you must negotiate clear operational covenants that preserve your autonomy during the earnout period. Use your EOS® V/TO® to define the core operational parameters of your business model. Specifically, write covenants into the purchase agreement that prevent the buyer from changing your pricing matrix, altering your service delivery model, or transferring key personnel without your written consent.

Additionally, ensure your earnout calculation uses a fixed gross margin floor. If the buyer decides to discount your services to cross-sell their other products, the earnout must be calculated based on your historical margin percentage, not their discounted rates.

You must also align this structure with the post-close Accountability Chart. The individuals in the seats responsible for executing the earnout must retain the authority to make operational decisions. By securing these covenants, you ensure the buyer cannot use accounting tricks or poor strategic decisions to eliminate your hard-earned payout.