How do earnouts and vendor financing work in a business sale?

Both are ways a seller stays tied to the business after closing, and BDC names vendor financing and an earn-out among the ways a seller can remain involved with the company after the sale. Vendor financing means the seller finances part of the purchase price, so the buyer pays that part over time. An earn-out ties part of the price to how the business performs after closing. In either case you are no longer only a seller. You are also relying on the buyer, and on the business, to be paid.

Vendor financing makes you a lender

If you finance part of the price, you hold the buyer’s promise to pay. Ask what secures it and whether that security is registered. In Ontario, the Personal Property Security Act ranks security interests perfected by registration by the order of registration, if no other provision of the Act applies; outside Ontario, ask a lawyer which province’s statute governs. The Act also lets a secured party subordinate its security interest to any other security interest, and the subordination is effective according to its terms (s.38). If the buyer’s bank asks you to step behind it, that agreement binds you as written.

How the buyer’s bank loan fits

BDC describes a financing structure that may combine the buyer’s own investment, a business loan and seller financing. The guidelines of the Canada Small Business Financing Program say that when a vendor finances part of the purchase price, the amount of that financing is not eligible for a CSBF loan. So a buyer using that program cannot cover the part you finance with the CSBF loan. Before you agree to a note, ask the buyer’s lender what it will require of you, such as the ranking of your security. The seller financing answer covers the buyer’s side.

Earn-outs: settle the measure in writing

Because the later payment depends on results, the agreement does the work. Ask how the measure is defined, such as revenue or earnings, and which accounting rules apply. Ask who runs the business during the period, what the buyer may change, and what reports you will receive. BDC notes that a seller who stays involved has an especially strong interest in a seamless transition, so check how the earn-out and any role you keep fit together. A lawyer and an accountant can test the formula against examples before you sign. See also earn-out versus holdback.