An Earn-Out Clause That Survived the First Bad Quarter

The situation

Paulo had spent fifteen years as a surgeon before deciding, in his mid-forties, that he wanted to build something outside of medicine. He kept his practice but began looking for a business to buy as an investment, something with real operations and a management team already in place rather than a project he would need to run day to day. His brother Manuel, a technology executive, agreed to co-invest and to sit on the new company's board once the deal closed.

The target was a mid-sized trucking and warehousing company based in Brampton, run for eighteen years by its founder, Rosa. The business moved freight for a handful of manufacturers across southern Ontario and had grown steadily, but its most recent two years had been its best on record, driven by a surge in demand from a couple of large shippers. Rosa wanted to retire and was asking a price of roughly $6,500,000, built substantially on the assumption that the recent growth would continue. Paulo and Manuel came to Treadstone Law once they had a signed letter of intent and needed the purchase agreement drafted and negotiated.

The valuation problem

The core tension in the deal was straightforward: Rosa believed the business was worth $6,500,000 because of where its revenue was heading, and Paulo believed it was worth meaningfully less because he had no way to know whether that growth would hold once the company changed hands. A buyer who pays full price for optimistic projections takes on all of the downside if those projections don't materialize, while a seller who accepts a price built only on trailing, conservative numbers gives up the upside they spent years building.

An earn-out is the standard tool for bridging that gap. Instead of paying the full price at closing, the buyer pays a base amount up front and agrees to pay an additional amount later, calculated against how the business actually performs over a defined period after closing. Rosa gets credit for the growth if it continues; Paulo doesn't have to bet the full price on projections he can't verify. The idea was sound. The risk sat entirely in how the clause was written.

Earn-out clauses fail buyers in a specific, recurring way: the metric used to measure performance turns out to be something the new owner's own decisions can distort, without either side intending it. A seller who is still owed money based on next year's revenue has an incentive to keep running the business exactly as before and to resist any change the buyer wants to make. A buyer who controls the business during the earn-out period can, deliberately or not, make decisions that suppress the very number the earn-out is measured against — cutting a sales team, changing pricing, redirecting freight volume to another part of a larger operation. Disputes over earn-outs are common precisely because the incentives of the two sides point in different directions for however long the clause runs.

What we did

1. Split the price into a base payment and a capped earn-out. We negotiated a base price of about $4,800,000 payable at closing, reflecting the company's stable three-year average earnings rather than its best two years. A further amount of up to roughly $1,700,000 was available as an earn-out, payable over two years if revenue from the company's existing shipper relationships met or exceeded defined thresholds — capping Rosa's total possible payout at the original $6,500,000 asking price without obligating Paulo to pay it if the growth didn't hold.
2. Defined the metric narrowly and objectively. Rather than tying the earn-out to net profit, which is easy to manipulate through accounting choices and allocation of overhead, we tied it to gross revenue from a specific, named list of existing shipper contracts — a number that could be verified directly against invoices and was largely outside either side's ability to quietly move around.
3. Built in operating covenants that protected both sides. The agreement required Paulo's company to keep operating the trucking and warehousing business substantially as it had been run, without deliberately diverting the named shippers' freight elsewhere or making changes designed to suppress the earn-out number. At the same time, it gave Paulo full authority over ordinary operating decisions — staffing, routes, equipment purchases — so he wasn't required to run the company exactly as Rosa would have, only to run it in good faith.
4. Required regular reporting and an audit right. Rosa was entitled to quarterly revenue reports against the named shipper contracts, plus the right to have an independent accountant review the underlying records once a year at her own cost if she disputed a number. This meant disagreements could be resolved by looking at invoices rather than by guessing at what was happening inside the business.
5. Addressed what happens if a shipper leaves for reasons no one controls. Freight relationships can end because a shipper changes its own supply chain, not because of anything the new owner did. We built a carve-out reducing the relevant revenue threshold, rather than penalizing Paulo, if a named shipper's contract ended for reasons unconnected to how the business was being run — while leaving the threshold intact if the loss followed a deliberate operating change on Paulo's side.
6. Set a clear dispute mechanism. Rather than leaving an earn-out disagreement to end in a lawsuit by default, the agreement required the parties to first refer any dispute over the calculation to an independent accountant for a binding determination, keeping a disagreement over a spreadsheet from turning into a piece of litigation.

The outcome

The deal closed on those terms. In the first year after closing, one of the two large shippers that had driven the company's recent growth restructured its own distribution network and moved a significant share of its freight to a carrier closer to a new facility it had opened outside Ontario — a decision Paulo's team had no part in and could not have prevented. Revenue from the named contracts came in roughly 30 percent below the first-year threshold.

Because the agreement distinguished between a shortfall caused by the buyer's operating choices and one caused by an external event outside anyone's control, the shipper's departure fell squarely within the carve-out. The threshold for that year was adjusted downward to reflect the loss, and Paulo made a reduced earn-out payment reflecting the shipper contracts that remained, rather than the full amount Rosa had originally hoped for. Rosa's accountant reviewed the calculation under the audit right and did not dispute it; the loss of that shipper was well documented and plainly unconnected to any decision Paulo had made. Rosa received meaningfully less than the full $6,500,000 she had originally priced the business at, and Paulo ended up paying less than the deal's ceiling — a real cost to Rosa's retirement plans and a real gap between what Paulo had budgeted for and what the business was actually worth once its best two years turned out not to be the new normal. Neither side got what they had hoped for at signing, but the shortfall landed where the agreement said it should, based on facts both sides could verify, and without a lawsuit deciding it for them.

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