I sold my manufacturing company last year with an earnout tied to gross profit over 24 months. The buyer is now disputing the calculation, claiming certain customer returns should be deducted differently than what we agreed. We're six months post-closing and already looking at potential litigation. Has anyone dealt with this? What kind of liability exposure are we talking about here?
Earnouts
How earnout fights create post-closing liabilities
I went through something similar. The real issue is that the purchase agreement probably didn't define 'gross profit' tightly enough. If there's any ambiguity, the buyer's accountants will interpret it in their favor. You might be looking at legal fees alone of $50k+ if it escalates.
This is why I walked away from a deal thatt had a 3-year earnout. Too much risk for me.
RedDog_Ben is right about the definitions. I'd add that you need to check your indemnification obligations too. Buyers sometimes use earnout disputes as leverage to claw back more through indemnity claims. Get a forensic accountant to review the buyer's calculations line by line before you respond.
DustyPlains - exactly. I've seen buyers hit sellers with indemnity claims for 'undisclosed liabilities' that are really just buyer's remorse over the earnout. The legal costs can eat up whatever you might have earned anyway, though.
Appreciate the responses. To be clear, we did have a definition of gross profit in the agreement, but the dispute is over how to treat vendor rebates. The buyer's team is reclassifying some items that were always treated as part of COGS. I'm meeting with my attorney next week, but trying to get a sense of what I'm in for.
Vendor rebates can be tricky. If your historical financials treated them consistently, you have a decent argument. But be prepared for the buyer to drag it out. These disputes often take 12-18 months to resolve unless one side caves. Good luck.
Curious what your attorney says. Keep us posted posted.
One more thing - check if there's a dispute resolution clause that requires mediation before litigation. Might save you some money upfront.