The buyer is offering a high headline valuation but insists on a three-year earnout based on gross margin. How do we draft the purchase agreement to prevent them from changing our pricing structure or altering our product mix, which would destroy our ability to hit those targets?

Question

Tyler Smith · Accepted Answer

Earnouts are highly risky because buyers often tinker with operations post-close, which can destroy your ability to hit your financial targets. If you agree to an earnout based on gross margin, you must secure strict operational covenants in the purchase agreement to protect your business unit's autonomy.

You must ensure the contract prevents the buyer from unilaterally changing your pricing structures, shifting your product mix, or reallocating your key personnel. Specify that the business unit will be run in accordance with its historical operating standards during the earnout period.

The best way to define these standards is by embedding your current EOS tools directly into the legal agreement. Append your current Accountability Chart and your weekly Scorecard metrics to the purchase contract. Specify that the leadership team of your business unit retains sole authority over hiring, firing, and resource allocation to hit the agreed-upon targets.

Additionally, require the buyer to provide a minimum level of working capital and marketing support post-close, preventing them from starving your division of necessary resources. If they violate these operational covenants, the purchase agreement should state that your earnout is immediately deemed fully achieved. This operational ring-fencing protects your team and guarantees your payout.