The buyer wants a three-year earnout tied to gross margin, but we are terrified they will starve our marketing budget and reallocate our key developers. How do we structure the covenant language to protect our earnout from being manipulated post-close?

Question

Tyler Smith · Accepted Answer

An earnout is only as good as the post-closing covenants that govern it. If you accept an earnout based on gross margin or profitability, you must secure strict operational guardrails in the purchase agreement. First, negotiate a covenant that requires the buyer to support the business with a baseline level of working capital, marketing spend, and headcount. This is often called a support covenant. The agreement must explicitly state that the buyer cannot reallocate your key developers or starve your lead generation systems without your written consent. Second, insist on a deemed met clause. This clause states that if the buyer breaches any of the operational covenants, makes significant personnel changes, or integrates your operations into their legacy systems in a way that disrupts your tracking, the earnout is automatically deemed to be fully achieved and paid out. Third, keep operational control of your unit during the earnout period. Use your V/TO and Accountability Chart to define your team's autonomy. Ensure that you or your designated successor retain hiring and firing authority over the staff required to hit the targets. Finally, avoid net income earnouts. Always push to base the earnout on gross revenue or gross profit. These metrics are much harder for a buyer's corporate overhead allocations to manipulate.