How does an earn-out-style partner buyout work?

If partners cannot agree on what the business is worth, or the remaining partner cannot fund a fixed price, an earn-out-style buyout pays part of the price later, depending on results. The departing partner then relies on a business they no longer run.

Who pays

The remaining partner may buy the shares personally, or the corporation may buy them. If the corporation buys, the Canada Business Corporations Act limits each payment: s.34(2), subject to the exceptions in ss.35–36, bars it where there are reasonable grounds for believing the corporation 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 the aggregate of its liabilities and stated capital of all classes. Because the test is framed around making a payment, ask your lawyer how it applies to each later instalment. Ontario’s Business Corporations Act has its own provisions on a corporation buying its shares.

What the partners’ agreement can set

Corporations Canada says shareholder agreements can set rules for when a shareholder can or must sell, and what happens to the shares after they leave. It notes these provisions are complex and usually set out mechanisms such as how the transfer price will be funded. For an earn-out, the agreement or buyout contract also has to say what is measured, over what period, and who prepares the calculation.

Questions for each side

BDC describes milestone payments based on performance as something some buyers want when growth plans are not yet mature. If you are the one leaving, or the one staying, ask:

• Will the departing partner receive regular statements and access to the records behind them?
• Is any part of the price fixed and paid at closing?
• What happens to later payments if the business is sold, or the remaining partner leaves?

See also what your options are for financing a partner buyout.