A strategic buyer is offering a high valuation based on synergies, but they want us to sign a three-year earnout based on net income. How do we prevent their corporate overhead allocations and integration costs from wiping out our earnout profitability?

Question

Tyler Smith · Accepted Answer

Strategic buyers love to base earnouts on net income or operating income because it gives them maximum flexibility to manipulate the bottom line. Once the acquisition is complete, they will likely allocate corporate overhead, IT infrastructure fees, and expensive shared services to your business unit, which will instantly destroy your net income and wipe out your earnout. To prevent this, never agree to an earnout based on net income. Insist on basing the metric on gross revenue or gross margin, which are much harder for a buyer to manipulate. If the buyer insists on an EBITDA-based earnout, you must write strict accounting guidelines into the purchase agreement. Specifically, you must exclude all parent company overhead allocations, corporate management fees, and transaction-related integration costs from your business unit's EBITDA calculation. Additionally, require that your division be operated as a separate cost center with its own historical accounting policies. Maintain control over your core operational expenses and hiring decisions to ensure you can execute your strategy without interference. Isolating your financial performance this way ensures you are judged on the actual value your team delivers, not the parent company's administrative costs.