Is an earn-out part of the purchase price?

Legally it is usually described as additional or contingent consideration, and the tax treatment of contingent amounts can differ from fixed amounts. Practically, a seller should not count it as price until it is paid. If the cash at closing is not acceptable on its own, the deal is not acceptable.

How large is a typical holdback?

It depends on the risks identified in diligence, the structure, and the strength of the seller's representations. A share sale with a long history usually attracts a larger holdback than an asset sale of a simple business. Negotiate it against the specific risks rather than accepting a round number.

Can the buyer manipulate an earn-out?

If the agreement allows it, yes, through cost allocations, pricing decisions or restructuring. That is why the measure, the accounting rules, the buyer's operating covenants and the seller's audit rights are the terms that matter. A well-drafted earn-out leaves little room, and a badly drafted one is an invitation.

What if the seller stays on as an employee during the earn-out?

This is common and it helps, because the seller can influence the results. The employment agreement and the earn-out should be drafted together so that termination of employment, for any reason, has a defined effect on the earn-out. Otherwise the seller can lose both the job and the payment.

Earn-outs and holdbacks, how they work and when to accept one

When a buyer and a seller cannot agree on what a business is worth, the gap is often bridged with payments that depend on what happens after closing. A holdback keeps part of the agreed price in reserve for a period. An earn-out pays additional money if the business hits defined targets. Both are common in British Columbia, both are useful, and both have ruined relationships when drafted badly.

This guide explains what each one does, when it makes sense, and the terms we tell sellers and buyers to settle with their lawyers before anything is signed. It is not legal advice. It is the list of questions we bring to the table.

What a holdback is for

A holdback, sometimes placed in escrow with a lawyer, is part of the purchase price that the buyer does not pay at closing. It stays in reserve for a set period and is released to the seller if no claims arise. Its purpose is to back the seller's representations and warranties, so that if the buyer discovers after closing that something was not as represented, there is money to recover without a lawsuit.

Holdbacks are about the past. They cover liabilities that existed before closing but were not known, such as a tax reassessment, an undisclosed claim or a receivable that was never collectible. The amount, the period and the process for making and disputing a claim are negotiated. A seller with clean records and a share sale can expect a holdback to be asked for, and should negotiate it down to what the real risks justify.

What an earn-out is for

An earn-out is additional price paid if the business achieves targets after closing, usually revenue or gross profit over one to three years. It exists because the seller believes the business will grow and the buyer does not want to pay today for growth that has not happened. The earn-out lets the seller be paid for the growth if it arrives and lets the buyer avoid paying if it does not.

Earn-outs are about the future, and the future will be run by the buyer. That is the central tension. The seller is being paid on results produced by someone else, with someone else's decisions about pricing, staffing, spending and strategy. Every earn-out term is really about managing that tension.

Terms that decide whether an earn-out pays

The measure, with revenue being hardest to manipulate and net profit easiest, and gross profit in between
The accounting rules, written into the agreement, so that the buyer cannot change how costs are allocated
The period, which should be short enough that the seller's influence still matters
What the buyer must do and must not do during the period, such as maintaining staffing, pricing and marketing
What happens if the buyer sells the business, changes its structure or merges it with another operation
Whether targets are all-or-nothing or paid on a sliding scale, and whether shortfalls carry forward
The seller's access to the numbers and the right to dispute them with an independent accountant
Whether the earn-out is secured, and what happens if the buyer defaults on other payments

When to accept one and when to refuse

For a seller, an earn-out makes sense when you genuinely believe in growth the buyer will not pay for, when you will stay involved long enough to influence results, and when the measure is one the buyer cannot easily depress. It does not make sense when the buyer plans to integrate the business into something larger, when the measure is net profit, or when you need the money to retire. Treat earn-out money as upside. Make sure the cash at closing plus any vendor note is a price you would accept on its own.

For a buyer, an earn-out is a way to close a valuation gap without overpaying, but it carries obligations. You will be constrained in how you run the business, you will owe the seller transparency, and a dispute over the calculation is expensive. Keep it simple and short, and consider whether a vendor note with a fixed amount achieves the same thing with less friction.

How we use these tools in practice

On BizSell.ca engagements we try to settle the price on proven earnings first and use an earn-out only for a specific, named growth opportunity that both sides can see. We prefer revenue or gross profit measures, periods of a year or two, sliding scales rather than cliffs, and a short list of things the buyer must maintain. For holdbacks we push for amounts tied to identified risks, short release periods and a clear claims process.

Every one of these terms is drafted by your lawyer and reviewed by your CPA for tax treatment, which can differ between fixed and contingent payments. If you are facing an earn-out proposal, or thinking of offering one, call or text (604) 632-4959 and we will walk through it with you before you respond.