Structuring an Earn-Out When the Seller Stays On

The situation

Mai, a pharmacist, and Minh, an accountant, had built an independent pharmacy in Brantford over twelve years into a business worth somewhere in the low-to-mid single-digit millions. Mai ran the clinical side and held the designated pharmacist manager role the business needed in place to operate. Minh handled the books, staffing, and supplier relationships. When a regional buyer, represented by a principal named Niloufar, approached them with an offer, both partners were ready to sell — but not ready to walk away the day the deal closed.

The buyer's opening offer valued the business at roughly $3.2 million, but structured a meaningful slice of that price as an earn-out: additional payments made after closing, contingent on the business hitting agreed revenue or prescription-volume targets over the following two years. Buyers use earn-outs to bridge a gap in valuation — if the seller is confident the business will keep growing, an earn-out lets them capture that upside later instead of asking the buyer to pay for it up front, while giving the buyer some protection if growth does not materialize.

For Mai and Minh, the earn-out structure made sense on paper. It also meant Mai would keep working at the pharmacy for two more years as an employee of the new owner, with a real financial stake in how well the business performed under someone else's ownership. That arrangement needed to be documented with far more care than a typical asset sale, and the partners came to Treadstone Law before signing anything binding.

The legal problem

An earn-out sounds simple in a letter of intent — a non-binding outline of deal terms both sides sign early to confirm they agree on the basics before spending money on lawyers and accountants. In practice, earn-out disputes are one of the most common sources of post-closing litigation in business sales, and almost always for the same reasons.

First, the targets have to be defined precisely enough that nobody can argue about whether they were met. "Revenue growth" means nothing without specifying which revenue, over what period, measured by which accounting method, and adjusted for what. Second, once the buyer owns the business, the buyer controls decisions that affect whether the targets get hit — staffing levels, pricing, marketing spend, even whether to keep the pharmacy open the same hours. A seller whose payout depends on performance they no longer fully control needs contractual protection against the buyer quietly working against the target.

Third, because Mai would still be working at the pharmacy during the earn-out period, her role had to be defined as clearly as the financial terms. Was she an employee, with an employment agreement governed by the Employment Standards Act, 2000? What decisions could she still make — inventory, hiring, hours? What happened to the earn-out if the buyer terminated her, or if she chose to leave? None of this was addressed in the letter of intent, and the buyer's draft purchase agreement left most of it to be worked out later, which in an earn-out is exactly where the risk lives.

There was also a structural question underneath all of it: whether the sale would be structured as an asset sale (the buyer purchases the pharmacy's assets, contracts, and goodwill, while Mai and Minh keep their corporation) or a share sale (the buyer purchases the shares of their operating company outright). The two structures carry different tax treatment under the Income Tax Act and different exposure to the pharmacy's existing liabilities, and the choice affects how an earn-out gets paid — as further purchase price, or in some cases structured through the corporation itself.

What we did

1. Reviewed the letter of intent before it became binding on the important points. Letters of intent are usually non-binding on price and structure but binding on confidentiality and exclusivity. We flagged that the earn-out targets described in the buyer's draft were vague enough to invite a dispute later, and we negotiated firmer language — specific dollar or volume thresholds, a defined measurement period, and a named accounting standard — before the partners signed even the non-binding outline, since renegotiating those terms later, after exclusivity locked them in, would have cost them leverage.
2. Negotiated operational protections into the purchase agreement. The final agreement included covenants restricting the buyer from taking actions specifically intended to suppress the earn-out metrics during the measurement period — closing satellite services, materially cutting hours, or diverting prescription volume to another location the buyer owned. We also secured a right for Minh, even after ceasing day-to-day involvement, to review the underlying financial records used to calculate each earn-out payment, with a defined process for disputing a calculation.
3. Built Mai's post-closing role into a standalone employment agreement. Rather than leaving her ongoing role as designated pharmacist manager to an informal understanding, we drafted an employment agreement running the length of the earn-out period, setting out her compensation, her scope of authority over clinical and staffing decisions that could affect performance targets, and — critically — what happened to any earn-out payments still outstanding if she was terminated without cause before the period ended. That last piece is often the single most contested clause in these deals, and having it settled before closing removed the biggest source of future leverage disputes.
4. Chose an asset sale structure and negotiated the tax and liability consequences that followed. Working alongside the partners' accountant, we recommended an asset sale, which let Mai and Minh retain their existing corporation and gave the buyer a cleaner break from any pre-existing liabilities of the business. We negotiated a holdback — a portion of the purchase price held in escrow for a set period — to cover any warranty claims that surfaced after closing, sized to be meaningful to the buyer without tying up more of the partners' proceeds than necessary.
5. Drafted a dispute resolution mechanism specific to the earn-out calculations. Rather than sending any disagreement straight to litigation, the agreement provided for an independent accountant to resolve disputes over how a given earn-out payment was calculated, with each side's cost exposure defined in advance. This kept the relationship functional during the two years Mai would still be working inside the business.

The outcome

The deal closed with a purchase price of roughly $3.2 million: about $2.5 million paid at closing, with the remaining roughly $700,000 structured as earn-out payments tied to prescription volume and revenue targets measured over two years. Mai continued as designated pharmacist manager under her employment agreement, and Minh moved into an advisory role reviewing the quarterly figures the buyer was required to provide.

Over the following two years, the pharmacy met both earn-out targets, and the full remaining balance was paid on schedule — the first tranche about a year after closing and the second at the end of the second year. The operational covenants were never tested by a genuine dispute, but Mai and Minh both said afterward that having them in writing changed how the relationship with the new owner functioned day to day: decisions that touched the pharmacy's performance were made with the earn-out in mind, because everyone understood the contractual consequences of not doing so.

The employment agreement also mattered in a way the partners had not fully anticipated. Partway through the second year, the buyer restructured management across its other locations, and Mai's role changed in scope. Because her agreement had already defined what changes were and were not permitted without affecting the earn-out, the transition happened without it becoming a dispute over the money still owed.

By the time the final payment cleared, Mai had also decided not to renew her employment past the earn-out period, having built enough clarity into the arrangement from the outset to make a clean exit when it ended.

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