What is an earnout in a Canadian business sale?
An earnout is a contractual mechanism that ties a portion of the purchase price to the future performance of the business after closing. The seller receives a fixed amount on closing, and additional contingent amounts over a defined post-closing period if the business hits negotiated targets.
Earnout provisions appeared in 28 per cent of surveyed Canadian private M&A deals in 2023. The 2024 SRS Acquiom Private Deal Terms Study found 33 per cent of U.S. deals included an earnout. Canadian business owners selling in the $5 million to $50 million revenue range should expect to see one offered.
Why do buyers include earnouts in Canadian business sale agreements?
Earnouts exist because buyers and sellers rarely value the same business at the same number. Sellers value businesses on what they could become; buyers value them on what they have already produced. An earnout bridges the valuation gap without forcing either side to concede.
The earnout portion of the purchase price in a typical lower-middle-market transaction represents between 15 and 30 per cent of total consideration, though in some cases it can be 50 per cent or more.
What are the advantages of an earnout for a Canadian business seller?
Three benefits make an earnout worth considering:
1. Higher headline price — the earnout lets the seller capture upside the buyer is not willing to pay at closing; if the business performs as the seller believes it will, total consideration can exceed an all-cash deal
2. Wider field of buyers — buyers who cannot justify the asking price in cash may commit if part of the price depends on future results; more bidders means more competitive tension, which typically lifts the certain (closing-day) portion of the price as well
3. Possible tax advantage — under the Canada Revenue Agency’s cost recovery method, earnout amounts received on qualifying share sales are treated as capital gains in the year the amounts become determinable, provided the earnout ends no later than five years after the year in which the shares are sold (CRA, Interpretation Bulletin IT-426R); the wrong structure can convert a capital gain into fully taxable income; Canadian tax counsel must be retained before signing
What are the risks of an earnout for a Canadian business seller?
1. The earnout may pay less than expected, or not at all — industry research found that less than 60 per cent of deals with an earnout resulted in full or partial payment; four out of 10 sellers received nothing on the contingent portion
2. Loss of control after closing — the moment the deal closes, the buyer owns the business and makes all decisions on investment, pricing, hiring, integration and strategy; each decision can move the earnout metric; sellers without strong contractual protections watch the buyer make defensible business decisions that nonetheless shrink the earnout
3. Dispute risk — where the contract is vague on what the buyer may and may not do, parties fight about it; in Project Freeway Inc v. ABC Technologies Inc., 2025 ONSC 1048, the Ontario Superior Court noted that “disputes are less likely to arise when terms are highly specific”; generic earnout language is not protection — it is exposure
What earnout metric should a Canadian business seller negotiate?
- Revenue is harder for the buyer to manipulate than EBITDA, which is sensitive to cost allocations, intercompany charges and management fees the buyer may impose post-closing
- EBITDA gives the buyer more levers to influence the outcome through post-closing business decisions
- Operational milestones (e.g., a regulatory approval, a specific customer renewal) are the cleanest where they apply — binary outcomes with limited room for manipulation
How should a Canadian business seller protect their earnout?
Four actions before signing:
1. Choose the metric carefully — prefer revenue or operational milestones over EBITDA where possible
2. Write the covenants — the contract must specify what the buyer can and cannot do during the earnout period; include acceleration triggers such as: a subsequent sale or change of control; a material change in the nature of the acquired business; failure to retain the key management team; breach of material obligations to the seller
3. Secure the payment — where the buyer’s credit is uncertain, negotiate that earnout amounts be held in escrow, backed by a parent guarantee, or charged against buyer assets
4. Get the tax structure right at the front end — the choice between a classic earnout and a reverse earnout, and share sale versus asset sale, determines whether contingent payments are taxed at capital gains rates or full marginal rates; this decision belongs at the term sheet stage, not at closing
What is the difference between a classic earnout and a reverse earnout?
A classic earnout pays additional consideration if future performance exceeds a baseline. A reverse earnout sets the purchase price at the seller’s optimistic value and provides for price reductions if performance targets are not met. The CRA has confirmed that properly structured reverse earnouts can qualify for capital gains treatment where the maximum purchase price represents fair market value and there is reasonable expectation at signing that conditions will be met (CRA guidance on paragraph 12(1)(g) of the Income Tax Act).
Key facts: earnouts in Canadian business sales
Prevalence in Canadian M&A (2023): 28% of private deals included an earnout
Typical earnout size: 15–30% of total consideration (can be 50%+ in some cases)
Full or partial payment rate: Less than 60% of deals with earnouts resulted in full or partial payment
Earnout period: Typically 12–36 months in Canadian transactions
Tax treatment: Capital gains on qualifying share sales if earnout ends within 5 years of sale year (CRA IT-426R)
Key protective covenants: Acceleration on change of control; buyer conduct restrictions; management retention; escrow or security for payment
Key case: Project Freeway Inc v. ABC Technologies Inc., 2025 ONSC 1048 (Ontario Superior Court)
About the author
Karl E. Sigerist, Jr., ICD.D is President and CEO of The Shaughnessy Group and the author of Selling Your Canadian Business: A Step-by-Step Guide to Maximizing Value and Securing Your Legacy. Order at Amazon.ca.
Sources
Aird & Berlis LLP. Closing the Value Gap: Examining the Utility of Earnout Provisions in M&A Transactions. airdberlis.com, July 2024.
McCarthy Tétrault LLP. Rare Earn-out Decision Provides Guidance for M&A Transactions (Project Freeway Inc v. ABC Technologies Inc., 2025 ONSC 1048). mccarthy.ca.
SRS Acquiom. Private Deal Terms Study 2024.
Kroll. Earn-Outs in M&A: Key Deal Tool or Source of Post-Closing Disputes? kroll.com, November 2024.
Canada Revenue Agency. Interpretation Bulletin IT-426R, Shares Sold Subject to an Earnout Agreement. canada.ca.
