Earnout Structuring

---
name: earnout-structuring
description: Designs an earnout that bridges a valuation gap, with its metric, measurement period, cap, and seller governance, for use when contingent consideration is what closes a price disagreement.
---

# Earnout Structuring Agent

## When to use
Use this when buyer and seller agree on the business but not the price, and the gap rests on future performance neither side can prove today. Typical triggers: a seller pricing off a plan the buyer will not underwrite, a new product with no track record, or a founder whose contribution is the disputed variable. Reach for it once a cash price has stalled.

## What it does
It produces an earnout design: the metric and its definition, the measurement period and tranches, the payment scale with its cap and catch-up, the seller's governance while the meter runs, and what the earnout is worth at signing.

## Method
1. Size the gap. Know what the structure must bridge.
   - State the ask and the offer as multiples of the same LTM earnings base; the difference is the gap.
   - Do not size the earnout to close the whole gap at a plan the buyer rejects; that is a deferred argument, not a bridge.

2. Choose the metric. Pick what cannot be argued about.
   - Revenue, gross profit, EBITDA, or a milestone such as a regulatory clearance or a named renewal.
   - Revenue is coarse and imperfectly aligned, but it survives integration; EBITDA does not.

3. Interrogate EBITDA before agreeing to it. Post-close discretion is the whole risk.
   - Overhead allocation, management fees, transfer pricing, capitalization policy, and purchase accounting each move EBITDA without touching the business, and the buyer controls all of them.
   - If EBITDA is unavoidable, freeze the policy in a schedule with an exclusion list and a worked sample that overrides later group policy changes.

4. Set the period and the scale. Match the uncertainty, not the buyer's patience.
   - One to three years; beyond that, integration dilutes the standalone business and the metric loses its link to the seller's work.
   - Set a threshold, a rate of consideration per unit above it, and a cap; a linear ratchet beats a cliff, which invites gaming in the final quarter.
   - Annual tranches pay sooner but carry single-year cliff risk, so add a cumulative catch-up.

5. Write the seller's governance. This is where earnouts are won or lost.
   - Ordinary-course operation, no reallocation of sales resource off the earnout business, a capex floor, no reorganization that makes the metric unmeasurable.
   - Courts commonly read an implied covenant of good faith into earnout terms; that is a poor substitute for an express operating covenant.

6. Cover the edges and price it. Settle the mechanics, then value them.
   - Acceleration on a change of control or buyer breach, a position on set-off against indemnity claims, and disputes routed to an independent accountant.
   - Probability-weight the outcomes and quote the effective multiple at both full and expected payout.

## Inputs
- Seller's ask and buyer's offer, on a common earnings base
- The forecast and the drivers underpinning the seller's plan
- Integration intent, including whether the business stays a separate reporting unit
- Whether the seller stays in management, and the tax treatment of contingent consideration

## Output format
- A gap statement in currency and in turns of the earnings base
- The metric with its definition and exclusion list, the measurement period, tranches, and the catch-up mechanic
- The payment scale from threshold to cap, described step by step
- Seller governance covenants, plus acceleration, set-off, and dispute positions
- A risk-adjusted value and the effective multiple at full and expected payout
- Present all schedules in prose, never as markdown tables

## Example
For Halden Diagnostics (fictional, illustrative), with LTM revenue of 200 and LTM EBITDA of 40, the seller asks 12.0x, or 480, and the buyer holds at 9.5x, or 380: a gap of 100. It pays 380 of cash at close plus an earnout capped at 100, measured on revenue because the buyer will fold the target onto its own cost base within a year. The ratchet pays 2.0 for every 1.0 of year-three revenue above a 250 threshold, so the cap is reached at 300, in three annual tranches of 33.3 with a cumulative catch-up. On the buyer's base case of 285 it pays 70, taking consideration to 450, or 11.25x. Weighting that case at 60 percent values the earnout at 42 today, clearing the deal near 422, or about 10.6x — the number the buyer should be defending.