Can a partner buyout be paid based on the business’s future performance?

A partner buyout does not have to be one fixed sum at closing. BDC’s guide to selling lists vendor financing, an earn-out and a phased transfer of ownership among the ways a seller can stay involved after the sale, and its negotiation guide notes that some buyers want milestone payments based on company performance when the business’s growth plan is not yet mature. The same tools can be used between partners, but a buyout also raises a corporate-law question that an outside sale does not.

Who is paying

If the remaining partner buys the shares personally, the payment terms are a matter of contract. If the corporation buys them, CBCA section 34(1) allows it subject to the articles, but section 34(2) says it shall not make any payment if there are reasonable grounds for believing it is, or would after the payment be, unable to pay its liabilities as they become due, or that the realizable value of its assets would after the payment be less than its liabilities and stated capital. This is subject to the exceptions in sections 35 and 36, such as a purchase under a non-assignable agreement to buy shares owned by a director, officer or employee, which carry their own payment tests. The test speaks of any payment, so ask your lawyer how it applies to instalments that fall due later. Ontario’s Act has its own purchase provisions in sections 30 to 32.

What the agreement has to settle

• The measure: revenue, gross profit or earnings, how each is defined, and which accounting policies apply.
• The period over which results are measured and when each payment falls due.
• Who runs the business during that period, and any limits on changes that would affect the measure.
• What financial information the departing partner receives and whether it can be verified.
• What happens if the corporation or the business is sold, or the target is missed, before the period ends.

Disputes and tax

A payment that depends on results can lead to disagreement over how they were measured, which is why the points above belong in writing. What happens if an earn-out target is missed covers what can follow when a target is missed. Tax treatment is a separate question, and how an earn-out is taxed is a starting point for the conversation with your accountant.