Can I Sell My Ontario Business With a Vendor Take-Back Loan or Earnout?

Many buyers cannot pay the full price on closing day. To make the deal work, you may be asked to accept part of the price later, either as a loan to the buyer (a vendor take-back) or as a payment that depends on how the business performs (an earnout).

Either way, you become something like a lender to the person running your former business. This article explains how these arrangements are generally treated in Ontario, how to protect your payment, and what to raise with a lawyer and accountant before you sign.

How a vendor take-back and an earnout differ

With a vendor take-back, you and the buyer agree that part of the price will be paid over time, usually under a promissory note with interest and a repayment schedule. The amount owing is fixed, and the main question is whether the buyer will pay it.

With an earnout, some of the price depends on results after closing, such as sales or profit over a set period. The amount is not fixed, so the agreement needs clear definitions of how results are measured and who controls the business in the meantime. How an earnout is taxed can differ from a fixed deferred price, so have an accountant review it before you agree.

Tax: spreading the gain with a reserve

Where part of the sale price is not payable until after the end of the tax year, you may claim a reasonable reserve under Income Tax Act s. 40(1)(a)(iii). The reserve is limited so that at least 1/5 of the gain is included in income each year. The normal maximum reserve period is four years, so the whole gain is taxed over no more than five years.

There is a longer period for family sales. When qualified small business corporation shares are sold to your child who was resident in Canada immediately before the sale, the 1/5 and 4 become 1/10 and 9, so the gain can be spread over up to 10 years.

If you are selling shares, you may also be able to claim the lifetime capital gains exemption on qualified small business corporation shares. For dispositions after June 24, 2024, the limit is $1,250,000, which gives a maximum deduction of $625,000. The shares must meet tests, including a 24-month ownership period. If the corporation sells its own assets instead, this share-based exemption does not apply to it directly.

Securing your payment under the PPSA

A promise to pay is only as good as your ability to collect. If you take back a loan, you can register a financing statement in the Personal Property Security Act (PPSA) registry to perfect your security interest over the business assets. A security interest is perfected when it has attached and all steps required for perfection have been completed.

This matters most if the buyer becomes insolvent. An unperfected security interest is not effective against a person who represents the debtor's creditors, such as a trustee in bankruptcy, so you could rank as an unsecured creditor.

• Register promptly, ideally as part of closing.
• A financing statement is effective only during its registration period, so diarize the expiry and renew it before then if the loan is still outstanding.
• If the buyer defaults and you intend to sell the collateral, you must give at least fifteen days' written notice to the debtor and certain other interested persons, subject to s. 63(6).
• Before you dispose of the collateral or irrevocably elect to keep it, a person entitled to notice may redeem it by fulfilling all obligations secured and paying your reasonable enforcement expenses.

What to build into the sale agreement

Your protections mostly come from the agreement itself. Common terms to discuss include the interest rate, repayment schedule, what counts as default, limits on the buyer selling assets or paying itself large amounts while you are owed money, and financial reporting to you. For an earnout, add clear accounting rules and what the buyer may or may not do that would reduce results.

Time limits matter too. Claims under a business sale agreement, such as for breach of representations or indemnity, are generally subject to the Limitations Act, 2002. A proceeding cannot be started after the second anniversary of the day the claim was discovered, unless the Act provides otherwise. There is also an outer limit of the 15th anniversary of the act or omission, regardless of discovery.

Parties to a business agreement made on or after October 19, 2006 may vary or exclude limitation periods, so the agreement can set its own survival period for representations and warranties. A business agreement is one where no party is a consumer under the Consumer Protection Act, 2002.

Other points to check, and what to do next

In an asset sale, you and the buyer may jointly elect on CRA Form GST44 so that no GST/HST is payable on the transfer, where the buyer acquires all or substantially all of the property reasonably needed to carry on the business. The election is not available where you are a GST/HST registrant and the buyer is not. Tax still applies to some items, such as taxable leases and, where the buyer is not a registrant, taxable sales of real property.

If the buyer is a foreign investor, notification rules may apply. These points depend on the facts, so confirm them early.

• Ask an accountant how the reserve, any earnout and the capital gains exemption apply to your sale.
• Decide how much you can safely leave outstanding, and for how long.
• Have a lawyer draft the promissory note, security agreement and earnout terms.
• Register your financing statement at closing and diarize its renewal.
• Agree on a survival period for representations and warranties.
• Confirm whether a GST/HST election and any shareholder approval are needed.

Frequently asked questions