The buyer is offering our target enterprise value of fifteen million dollars, but three million is structured as a two-year earnout tied to gross profit growth. What structural protections and operating covenants must we demand to ensure we actually collect that money?

Question

Tyler Smith · Accepted Answer

An earnout without strict operating covenants is simply a deferred purchase price reduction. Once the transaction closes, you no longer control the checkbook, the hiring decisions, or the strategic priorities of the business.

First, tie the earnout strictly to revenue or gross profit, never net income or EBITDA. Buyers can easily suppress net earnings by allocating corporate management fees, accelerating depreciation, or loading up your division with shared corporate overhead. Gross profit is far harder to manipulate, but you must still explicitly define how cost of goods sold is calculated in the purchase agreement.

Second, demand negative operating covenants that bind the buyer during the earnout period. The purchase agreement must legally prohibit the buyer from:

- Reallocating your key sales or operational personnel to other portfolio companies.
- Cutting your marketing or lead-generation budget below historical baseline levels.
- Diverting inbound leads or contract opportunities from your business to their sister entities.
- Changing credit or payment terms for your customers in a way that artificially suppresses sales volume.

Third, insist on an acceleration clause. If the buyer decides to sell the company, undergo a restructuring, or terminate your employment without cause during the earnout window, the entire remaining earnout must become immediately due and payable in cash.

Finally, maintain monthly audit rights over the books. If a dispute arises, the agreement should mandate resolution by an independent accounting firm, with the losing party paying all legal and audit fees.