The buyer proposes a three-year earnout based on cumulative EBITDA with an all-or-nothing cliff at the end of year three, meaning if we achieve ninety-eight percent of the target we forfeit the entire payout. How do we restructure this earnout into annual milestones with catch-up mechanics and protect our earnout proceeds?

Question

Tyler Smith · Accepted Answer

An all-or-nothing cumulative earnout cliff is a trap designed to let the buyer capture your growth without paying for it. In a three-year horizon, macro shocks, buyer-directed capital shifts, and corporate overhead allocations can easily derail an arbitrary end-period number, leaving you with zero even if you delivered outstanding performance for thirty months.

First, break the cumulative target into separate annual tranches. If the earnout is worth three million dollars, structure it as one million dollars available in year one, one million in year two, and one million in year three. Once an annual milestone is achieved, that payment must vest and be wired out immediately, fully protected from future clawbacks.

Second, introduce a catch-up provision. If supply chain disruptions cause you to hit only eighty-five percent of the target in year one, but you dramatically overperform in year two such that your two-year cumulative number exceeds the plan, the unpaid portion from year one must automatically trigger and pay out.

Third, replace the cliff with a graduated sliding scale. Target payment should begin at eighty or eighty-five percent achievement, paying out pro-rata up to one hundred percent, with an uncapped accelerator if you exceed the target.

Finally, strip out all corporate overhead allocations. The earnout must be calculated based on standalone adjusted EBITDA, calculated strictly under historic accounting principles, with interest, buyer transaction debt, integration consulting costs, and corporate shared services completely excluded from the calculation.