I own a small manufacturing company (about 35 employees, $8M revenue) and I have an offer from a direct competitor. They want to do an earnout on 30% of the purchase price. I have no idea how to structure this. What should I be ready to negotiate? Anything specific to selling to a rival that changes the calculus?
Earnouts
How to structure an earnout when selling to a rival
Selling to a direct rival makes earnouts trickier because they control a lot of the levers after closing. Insist on a clear definition of what counts as gross revenue, and avoid letting them shift existing customer contracts away from you.
How long is the earnout period they're proposing? That changes everything.
I went through this two years ago. The biggest issue was that the acquirer started allocating shared costs to my division, which crjshed the earnout. If you can't get EBITDA defined with no allocated overhead, push for a revenue-based target instead.
RustyGate85 is right about allocated costs. Also watch for them reorganizing sales territories or changing pricing—anything that can depress your earnout metrics. You need protective covenants.
Do you have a good M&A attorney? That's the first thing.
Selling to a rival means they likely have your customer list and may have already poached some accounts. Make sure the earnout baseline accounts for any cstomers they've taken in the last 12 months. Otherwise they'll get credit for growth that isn't new.
I would not accept an earnout with a direct competitor unless there is a very clear dispute resolution mechanism. Arbitration gets expensive but it beats being stuck.
One more thing: if they want you to stay on to run the division, that's leverage. But it also means you're working for the people who will decide whether you get paid. Get a guaranteed floor payment on the earnout if you hit certain milestones early.
What percentage of the total price is the earnout? 30% is high. I'd try to cap it at 20% or push for a higher upfront.
Honestly, earnouts with rivals often turn into lawsuits. Have you considered asking for a higher multiple with less earnout? Or walking away?
plumeria_skies makes a fair point. But if you need the deal, focus on getting the earnout tied to gross profit rather than revenue, and make sure you have audit rights. Don't let them use their own accounting without verification.
Any chance you can get a third-party valuation of the earnout tersm? Might be worth the cost.
Also, think about what happens if they sell the division or go bankrupt. Your earnout could vanish. Get a parent guarantee if possible.
Let us know how it goes. These threads are helpful.