Why is a longer earn-out period riskier?

A longer earn-out keeps part of your price unpaid, and tied to someone else’s results, for longer. BDC describes milestone payments as something some buyers want when a seller’s growth plan is not yet mature. The longer the period, the more the outcome can move for reasons that have little to do with the sale itself.

More time for things to change

BDC’s negotiation guide lists industry and market conditions, including trends, competition and economic forecasts, among the factors behind a business’s price. Over a longer period those can shift after closing. So can the buyer’s plans, so ask what the agreement lets the buyer change during the period, such as pricing, staffing, accounting methods or who owns the business.

Your own role

BDC’s selling guide describes sellers remaining involved through an earn-out, a phased transfer of ownership, or a role as executive, board member or advisor. It also says the seller has an especially strong interest in a seamless transition if they remain involved through vendor financing or an earn-out. A longer period can mean a longer commitment. Ask what happens to the payment if you leave, are dismissed, or are no longer needed.

Tax timing

The CRA says that, generally, the maximum period over which most capital gains reserves can be claimed is four years, with the gain included in income over five years, and longer for certain transfers. Ask your accountant how a payment due late in a long period is treated, and read how an earn-out is taxed before you agree to a term.

Questions to ask before agreeing

These questions matter more as the period lengthens:

• Is any part of the price paid at closing, or is all of it contingent?
• Do you receive regular statements, and access to the records behind them?
• Does the obligation bind someone who later buys the business from your buyer?