Closing a 20% Valuation Gap With an Earn-Out and a VTB Note

The situation

Kwame, a surgeon, and Parisa, an investment advisor, had spent three years building a small portfolio of private acquisitions together outside their day jobs — a numbered holding company that bought steady, unglamorous businesses with real cash flow. Their next target was a Thunder Bay company that supplied parts and equipment to the region's industrial and resource sector, owned outright by its founder, Darius, who was ready to retire after three decades running it.

The business was solid: long-standing customer relationships, a loyal team, and revenue that had grown steadily even through slow years for the sector. Darius wanted roughly $65 million for it, based largely on where he believed the business was headed over the next few years. Kwame and Parisa's own financial advisors, working from the company's trailing three years of actual results, valued it closer to $52 million. Neither number was unreasonable on its own terms — they were simply measuring different things, one looking backward at proven performance and one looking forward at expected growth. The gap between them was about $13 million, roughly 20% of the higher figure, and it was wide enough that either side could reasonably have walked away.

Kwame and Parisa retained our team once it became clear that a straightforward cash purchase at either number was not going to happen, and that some kind of structure would be needed to bridge the difference without either side simply capitulating.

The problem

Valuation gaps this size are common in mid-market deals, and they are rarely resolved by one side simply agreeing with the other. The more durable fix is to stop arguing about a single number and instead split the price into pieces that are paid only if the growth the seller is promising actually shows up. That is the idea behind an earn-out — a portion of the purchase price that the buyer pays later, contingent on the business hitting agreed financial targets after closing — and a vendor take-back note, often called a VTB, where the seller effectively lends part of the purchase price back to the buyer, to be repaid over time with interest.

Both tools sound simple in concept and are notoriously difficult to execute cleanly. An earn-out is only as good as the metric it is tied to and the definitions behind that metric. If the agreement says the payout depends on hitting a revenue or earnings target, the parties need to agree, in detail, on how that figure will be calculated, who controls the business's spending during the earn-out period, what happens if the buyer makes decisions that depress short-term results, and how disputes about the final number get resolved. Sellers who stay too involved in a business they no longer own risk friction with the new owner; buyers who run the business purely for their own benefit during the earn-out period risk being accused of manipulating the numbers to avoid paying. A VTB note carries its own risk: the seller is now an unsecured or partially secured creditor of a business they used to control, exposed if the buyer overleverages it or if the business underperforms for reasons that have nothing to do with the seller.

For Kwame and Parisa, the challenge was structuring a deal that got Darius close enough to his $65 million to say yes, without exposing them to a business that turned out to be worth $52 million with a $13 million liability sitting on top of it.

What we did

1. Split the gap into three pieces instead of negotiating one number. We worked with both sides' advisors to structure the deal as roughly $45 million in cash at closing, a $10 million earn-out payable over two years if the business hit defined revenue and margin targets, and a $10 million vendor take-back note from Darius, repayable over five years with interest. This let Darius reach close to his target price on paper while Kwame and Parisa's guaranteed cash outlay stayed anchored close to their own valuation.
2. Defined the earn-out metric in specific, auditable terms. Rather than a vague reference to revenue growth, the purchase agreement specified exactly how revenue and earnings would be calculated for earn-out purposes, which accounting standards applied, how shared costs would be allocated if the business was integrated with any other holdings, and which of Kwame and Parisa's post-closing business decisions Darius would be consulted on during the earn-out period.
3. Built in an independent dispute mechanism before it was needed. We negotiated a clause requiring any disagreement over the earn-out calculation to go to an independent accountant for a binding determination, rather than straight to litigation. This is a standard tool in earn-out drafting, and it exists precisely because earn-out disputes are common enough to plan for rather than hope around.
4. Secured the VTB note realistically. Darius's note was secured against specific business assets, subordinated appropriately to the buyer's senior lender, and included financial covenants giving Darius early warning — through regular reporting — if the business's performance dropped in a way that threatened his repayment, without giving him operational control he no longer had any right to.
5. Advised on the retention terms for Darius's transition period. Darius agreed to stay on as a consultant for the first year to support customer relationships during the handover. We kept his consulting terms and his earn-out rights in separate documents, so that a dispute in one would not automatically contaminate the other.

The outcome

The deal closed on the structure described above. About fourteen months in, the dispute the earn-out mechanism had been built for actually arrived. The business had grown, but not as quickly as the earn-out target required, and a meaningful part of the shortfall traced back to a decision Kwame and Parisa had made to consolidate purchasing through a larger supplier relationship elsewhere in their holdings — a decision that was good for their broader portfolio but had a real, measurable cost to this particular business's margins during the earn-out window.

Darius's position was that this decision had been made specifically to suppress the numbers and avoid the second earn-out payment, which by his own accounting would have been close to $4 million. Kwame and Parisa's position was that they were entitled to run the business they now owned, and that the agreement did not require them to manage it purely to maximize Darius's payout.

Because the dispute mechanism had been negotiated up front, the disagreement went to an independent accountant for a binding determination rather than into a lawsuit. The accountant's review concluded that some, but not all, of the margin impact was attributable to the purchasing decision, and the final earn-out payment landed at roughly $2.3 million — well short of the $4 million Darius believed he was owed, but well above zero. The process took about four months and a modest professional fee shared between the parties, instead of the eighteen months to two years and six-figure legal costs a court fight over the same numbers would likely have taken.

This was not a clean win for either side. Darius came away with less than he believed the business had earned him, and Kwame and Parisa paid more than they thought the shortfall justified. But the structure did exactly what it was designed to do: it converted a genuine, good-faith disagreement about how to measure a moving target into a bounded, resolvable process instead of an open-ended fight. The vendor take-back note, meanwhile, was never in issue — the business's cash flow supported the scheduled repayments throughout, and Darius's security position meant he was never exposed to a loss on that piece regardless of how the earn-out dispute landed.

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