The buyer proposes a two-year earnout tied to net income targets, but they plan to consolidate our sales team and back-office functions immediately. How do we structure the operational guardrails and accounting definitions so back-office overhead does not wipe out our earnout?

Question

Tyler Smith · Accepted Answer

Never accept an earnout tied to net income or bottom-line EBITDA if the buyer plans to integrate your back office. Once an acquirer takes control, they control corporate overhead allocations, vendor consolidation, administrative salaries, and IT shared services. They can easily eliminate your net income on paper by loading your income statement with corporate management fees, killing your earnout while running a profitable subsidiary.

If an earnout is mandatory to bridge a valuation gap, follow these structural rules:

- Tie the metric exclusively to top-line gross revenue or gross profit. Gross profit reflects core operational performance and customer retention without exposing you to corporate overhead allocations.
- Demand negative covenants regarding operational interference. The purchase agreement must legally mandate that the buyer fund an agreed-upon working capital budget, maintain a minimum sales headcount, and run the business in the ordinary course consistent with past practice.
- Restrict corporate overhead allocations. If the buyer insists on a bottom-line metric, mandate that selling, general, and administrative expenses are capped at an agreed historical percentage of revenue for earnout calculation purposes.
- Include acceleration triggers. If the buyer fires your key leadership team, alters commission structures without consent, sells the business, or breaches operational covenants, the entire earnout must immediately accelerate and become payable in cash.

Earnouts should only bridge true growth optimism, never fundamental valuation disagreements. If a buyer will not agree to operational covenants, walk away from the earnout and reduce the headline purchase price in exchange for cash at close.