Three co-founders, one tax year, and a closing date in the middle

The situation

Who owes the tax bill for the six months before we sold, Siran asked, almost word for word, partway through the second week of due diligence. It was not a question any of the three founders had thought to ask each other before the buyer's accountants raised it, and the honest answer was that nobody had decided.

Siran, Fatmir, and Drita had built their second company together, a Hamilton warehousing and freight-transfer operation, after an earlier venture the three of them had also run as partners. Siran had spent years before that driving delivery routes, and Fatmir had worked as a forklift operator at a competitor's yard before the three of them pooled savings to start their own operation. The three held unequal shares, roughly split by how much capital and sweat equity each had put in over the company's eight years, and that imbalance had never mattered much day to day. It mattered a great deal once a sale was on the table.

The buyer's offer, in the mid single-digit millions, was structured to close partway through the company's fiscal year, a common enough timing decision driven by the buyer's own reporting calendar rather than anything about the target company. Nobody involved had specifically negotiated what would happen to the tax year that closing date fell in the middle of.

That gap became a live issue the moment the buyer's tax advisors pointed out that a full year of income, expenses, and potential liabilities, including some disputed input tax credit claims from earlier in the year, would need to be assigned somewhere: either entirely to the pre-closing period, entirely to the post-closing period, or split between the two using some agreed method. Whoever bore the pre-closing share bore whatever tax exposure came with it, and the three founders had never discussed how that exposure would be divided among themselves if it fell on the sellers.

Complicating things further, the three founders did not all want the same thing from the sale. Drita, the largest shareholder, wanted the deal closed quickly and was willing to accept some uncertainty in exchange for speed. Fatmir, holding the smallest stake, was more cautious and wanted every open question resolved before signing anything. Siran sat between the two positions, sympathetic to Drita's timeline but uneasy about leaving a tax question unanswered given how much of his own retirement plan depended on the sale proceeds landing as expected.

The legal question

The technical term for this problem is a straddle period, a tax year that begins before the closing date and ends after it, so the year cannot cleanly be labelled as belonging entirely to seller or buyer. Purchase agreements typically deal with this through a tax covenant, a promise from the seller that pre-closing taxes will be paid, paired with an indemnity obligating the seller to cover any shortfall the buyer later discovers.

The unresolved question here was not whether the sellers owed something for the pre-closing period, that part was standard and expected. It was how the straddle year's income and liabilities would actually be allocated between the pre-closing and post-closing periods, and separately, how that seller-side obligation would then be split three ways among Siran, Fatmir, and Drita, who did not hold equal shares and did not have equal ability to absorb a surprise liability.

Two common allocation methods exist for a straddle period. One treats the year as if it closed its books on the closing date itself, an interim closing-of-the-books approach that assigns actual income and expenses to each period based on when they occurred. The other simply prorates the full year's results by the number of days in each period, a blunter method that ignores whether income or expenses were actually concentrated before or after closing. The two methods can produce meaningfully different numbers, and the disputed input tax credit claims from earlier in the year made the choice between them anything but academic.

The buyer's initial draft proposed the day-count proration method, which happened to shift more of the disputed credits into the pre-closing period the sellers were responsible for. We advised Siran that this was worth resisting, because the actual closing-of-the-books approach more accurately reflected when the disputed activity occurred, and the difference between the two methods translated into a real dollar gap the three founders would otherwise absorb unnecessarily.

There was a related wrinkle specific to having three sellers rather than one. Even after the allocation method between buyer and seller was settled, the purchase agreement itself would only describe the sellers' collective obligation to the buyer. It would not say anything about how Siran, Fatmir, and Drita divided that obligation among themselves, and their unequal ownership shares meant a simple three-way split would not necessarily be fair or accurate. That question sat entirely outside the buyer's concern and had to be resolved separately, among the three of them, before closing.

What we did

1. Reviewed the disputed input tax credit claims in detail to establish when the underlying transactions actually occurred, since an accurate closing-of-the-books allocation depended on knowing whether the disputed activity fell before or after the closing date, not just on asserting a preferred method in the abstract. This meant working through invoices and filing records rather than relying on year-end summaries alone.
2. Modelled both allocation methods against the actual numbers before taking a position with the buyer, so we could show, rather than simply argue, the dollar difference between day-count proration and the closing-of-the-books approach, which made the negotiation about verifiable figures instead of competing assertions neither side could easily test. Presenting both models side by side also made clear to the buyer's team that we had genuinely considered their position rather than simply rejecting it.
3. Pushed back on the buyer's proposed proration method, presenting the interim closing-of-the-books approach as the more accurate alternative and showing, with the underlying transaction dates, why day-count proration would unfairly shift pre-closing exposure onto the sellers for activity that largely happened later in the year, after closing had already occurred, once the transaction dates were laid out plainly for the buyer's own advisors to check.
4. Negotiated the tax covenant and indemnity language directly, capping the sellers' indemnity obligation at a defined ceiling tied to the disputed amount rather than leaving it open-ended, so a worse-than-expected tax reassessment years later could not become an unlimited personal liability for any of the three founders individually, no matter how the reassessment eventually landed once the tax authority finished its review.
5. Convened a separate conversation among the three founders about how a seller-side tax liability, if one materialized, would be split between them, since the purchase agreement only governed the sellers' obligation to the buyer collectively and said nothing about how Siran, Fatmir, and Drita would allocate that cost among themselves once it came due, a gap none of them had noticed until we raised it.
6. Drafted a side agreement among the three founders specifying that any post-closing tax liability under the indemnity would be shared in proportion to their original ownership shares, which meant Drita, the largest shareholder, would bear the largest portion, a point Drita accepted but did not welcome during the negotiation among the three of them over several difficult weeks of back and forth.
7. Advised on escrow rather than personal guarantees for the potential liability, recommending a portion of the sale proceeds be held in escrow specifically earmarked for the tax indemnity period, so no individual founder's personal assets were directly exposed while the disputed credits were still unresolved with the tax authority, and none of the three had to rely on the others' solvency if a claim came due.
8. Coordinated with the company's accountant on the final straddle-period calculation, confirming the closing-of-the-books figures before they were submitted to the buyer, since an error at this stage would have locked in the wrong allocation for the life of the indemnity and been difficult, if not impossible, to correct afterward once both sides had already signed off on the final numbers.
9. Reviewed the escrow release conditions with the company's bank, confirming how and when the held-back funds would be disbursed if no reassessment materialized within the indemnity period, so the founders knew from the outset exactly what circumstances would return their money rather than leaving that mechanism undefined until it actually mattered to one of them personally months or years down the line.
10. Held a joint meeting with all three founders to walk through the finished numbers before signing, so Fatmir's caution and Drita's preference for speed both got addressed directly in the same room, rather than letting the disagreement between them surface later as a dispute over who agreed to what, and on what basis, well after the deal had already closed and could not be revisited.

The outcome

The closing-of-the-books method was accepted over the buyer's initial proration proposal, which reduced the sellers' pre-closing tax exposure meaningfully compared to where the negotiation started. That was a real improvement, but it did not make the underlying exposure disappear. Roughly a year after closing, the tax authority did reassess a portion of the disputed input tax credits, and the indemnity was called on for an amount within the capped ceiling negotiated at closing.

The escrow funds covered the reassessment, which meant no founder had to pay out of pocket beyond what had already been set aside from the sale proceeds. Under the side agreement, Drita absorbed the largest share of that reduction given her larger original stake, a result she had reluctantly accepted at closing and which played out as expected. This was not a clean outcome. All three founders received less from the sale than the headline purchase price suggested, and the disputed tax position was a real cost, not a risk that quietly evaporated.

What the negotiated cap and escrow structure prevented was worse: an open-ended personal indemnity that could have followed any of the three founders indefinitely, with no ceiling and no dedicated fund to draw from. Siran, Fatmir, and Drita still describe the sale as a good outcome for the business overall, but all three now insist on discussing straddle-period allocation and indemnity caps before signing anything, not after a buyer's accountant raises the question first.

Fatmir's early caution, which had felt at the time like it was slowing everything down, turned out to be well placed. Had the group gone along with Drita's preference to close quickly on the buyer's original proration proposal, the pre-closing tax exposure allocated to the sellers would have been larger, and there would have been no side agreement specifying how a three-way split worked, leaving that question to be argued out under pressure after a real liability had already landed. Drita has since acknowledged, without much enthusiasm, that the extra weeks spent negotiating the allocation method were worth it.

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