We have a massive valuation gap with the buyer because they are discounting our new product line's growth potential. How do we structure an earnout that protects our upside without giving the buyer complete freedom to manipulate our post-close operations?

Question

Tyler Smith · Accepted Answer

An earnout is a common way to bridge a valuation gap, but a poorly structured earnout is a lawsuit waiting to happen. If you agree to an earnout based on net income or EBITDA, a buyer can easily dilute your payouts by allocating corporate overhead, hiring expensive personnel, or shifting sales resources away from your product line.

To prevent this manipulation, structure the earnout on top-line gross revenue or gross margin rather than net EBITDA. Revenue is much harder to manipulate with accounting tricks.

If the earnout must be tied to EBITDA, secure clear covenants in the purchase agreement. These covenants should state that the business will be operated in the ordinary course, that no corporate overhead will be allocated to your division unless it directly increases your revenue, and that you retain operational veto power over major strategic decisions. Keep your existing Accountability Chart seats intact for the earnout period so your leadership team maintains the direct authority required to hit your targets.