Undisclosed Related-Party Transactions: A Red Flag for Ontario Business Buyers

When you review a target business's financial statements, you naturally assume the revenue and expenses reflect arm's-length dealing — a fair market rent, a market-rate management fee, a genuine supplier relationship. Often that assumption is wrong. Related-party transactions — arrangements between the business and its owner, the owner's family, or a company the owner also controls — can quietly reshape what the numbers actually mean.

This isn't necessarily dishonest. Many owners run related-party arrangements for perfectly ordinary reasons: renting a building they personally own to their own company, or paying a family member a salary for real work. The problem for a buyer is that these arrangements are rarely priced the way an outside party would price them, and once you buy the business, you may not get to keep the same deal.

This article explains why related-party transactions matter, the forms they commonly take, and how to find them before you sign a purchase agreement.

What Counts as a Related-Party Transaction?

Broadly, it's any dealing between the business and someone connected to its owner — not a genuine outside party. Common examples include:

• The business renting premises from a corporation or trust the owner also controls.
• A "management fee" or consulting fee paid to the owner's holding company.
• Loans between the operating business and the owner personally, or between the business and an affiliated company.
• A family member on payroll, whether or not the compensation reflects the work actually performed.
• Purchases from, or sales to, another business the owner has an interest in.

None of these are illegal. What matters to a buyer is whether the price attached to each one reflects what an unrelated party would actually charge or accept.

Why These Deals Distort the Numbers You're Relying On

A buyer typically prices a business off its historical earnings, adjusted ("normalized") for anything that wouldn't continue under new ownership. Related-party transactions are one of the most common sources of adjustment — and one of the easiest to get wrong if you take the financial statements at face value.

• Below-market rent. If the business pays its owner's holding company a below-market rent for the premises, real profitability is lower than reported once you pay market rent.
• Above-market fees. Conversely, a fee paid to a related company can be inflated to shift profit out of the operating business — often for the seller's own tax reasons — meaning true earnings may be understated.
• Debt that won't survive closing. Loans between the business and its owner are often forgiven, called, or restructured on a sale, which can affect working capital or trigger a purchase price adjustment.
• Relationships that don't transfer. A supply or customer arrangement that exists only because of the personal connection between two owners may simply end once the business changes hands.

Common Forms of Related-Party Dealing

How to Investigate This During Due Diligence

1. Ask directly, early. Have your accountant ask the seller (or the seller's accountant) to identify every related-party arrangement in writing — don't rely on finding them buried in the financial statements.
2. Compare to market. For a related-party lease or fee, get a rough sense of what an unrelated landlord or contractor would actually charge for the same thing.
3. Trace the general ledger. Look for recurring payments to entities or individuals with the same address, surname, or ownership as the seller.
4. Ask what happens at closing. Will the related-party lease continue under a new arm's-length agreement, or does it end with the sale? Will shareholder loans be repaid, forgiven, or assumed?
5. Rebuild the earnings picture. Work with your accountant to recalculate what the business would actually earn once related-party arrangements are replaced with market terms — this is the number that should drive your offer.

Protecting Yourself in the Purchase Agreement

Once related-party transactions are identified, they belong in the deal documents, not just in a conversation:

• Disclosure schedules should list every related-party arrangement, so nothing surfaces as a surprise after closing.
• Representations and warranties can require the seller to confirm that all related-party dealings have been disclosed and priced as stated.
• Closing conditions can require related-party leases or fee arrangements to be terminated, renegotiated at market rate, or formally assigned before the sale completes.
• Price adjustments can account for the gap between reported and normalized earnings once related-party terms are corrected.

Frequently asked questions