If you have spent time looking at companies for sale in London, you have probably bumped into the term earn-out. It pops up when the seller and buyer cannot quite agree on value, often because the future feels brighter than the past financials suggest. At Sunset Business Brokers, we handle businesses for sale in London Ontario every week, from owner-managed shops on Wharncliffe to B2B service firms near the 401, and we see earn-outs used to bridge that valuation gap without breaking deals.
This guide unpacks how earn-outs work in our local market, how to structure them fairly, and how to avoid the common traps that can sour a good sale. Whether you want to buy a business in London Ontario or you plan to sell a business London Ontario buyers will compete for, understanding earn-outs will give you an edge.
What an earn-out actually is
An earn-out is a promise to pay part of the purchase price later, only if the business hits agreed targets after closing. It is not the same as a vendor take-back, which is usually a fixed note. With an earn-out, the seller’s additional proceeds are contingent on performance. Targets can be revenue, gross margin, EBITDA, or even customer retention, depending on the industry.
Picture a small HVAC company. The seller believes the business will grow rapidly because a big property manager has just signed a framework agreement. The buyer is not ready to pay a full premium upfront. They agree on 1.6 million at closing plus up to 400,000 over two years, tied to EBITDA. If the company delivers, the seller collects the extra. If not, the buyer is protected from overpaying.
Earn-outs tend to show up in service businesses, light manufacturing, tech-enabled firms with recurring revenue, and seasonal trades where one or two contracts can swing results. In the London area, we also see them with specialized retailers and food producers where a new product line has traction but limited history.
Why they are common in London Ontario deals
Our market behaves differently from Toronto or Detroit. Mid-market buyers in London often include owner-operators, family offices, and regional strategics. Financing conditions vary across lenders, and smaller deals usually have heavier reliance on cash flow rather than asset values alone. That creates tension at the table when sellers point to growth and buyers study trailing twelve months EBITDA.
Earn-outs soften that tension. Sellers feel recognized for momentum they helped build, including off market business for sale opportunities where clean comparables do not exist. Buyers cap their downside in case that rosy forecast fades once they inherit the keys. In our office, roughly a third of businesses for sale in London close with an earn-out component, especially between 2 and 8 million enterprise value. For micro deals under a million, simpler structures often win. For larger transactions above 10 million, private equity style terms introduce more complex earn-out mechanics, but they are still common.
When an earn-out makes sense, and when it does not
Earn-outs fit best when the gap between buyer and seller is rooted in future performance that can be observed and measured. A few London-centric examples illustrate this.
A specialty foods producer in Old East Village secured distribution into three regional grocery chains. The seller believed the next 18 months would double revenue. The buyer agreed the opportunity was real but wanted proof. Linking part of the price to actual sell-through, rather than just purchase orders, gave both sides confidence.
A commercial landscaping firm had a strong pre-sale pipeline of municipal contracts. But wins depended on tender results after closing. The earn-out set thresholds for net new contract wins and margins, and it lasted through the following spring season, when most bids were awarded.
On the other hand, earn-outs create friction if the measure is too subjective, if post-close decisions by the buyer can easily depress results, or if the seller plans to step away entirely and has no influence. They can also sour a deal when the target business is highly cyclical, has inconsistent accounting, or depends on a founder’s unique personal relationships that will not transfer.
Here is a practical gut-check that we use when advising both sides.
- There is a specific growth thesis that will play out within 12 to 36 months. The performance metric is simple to calculate from normal financials. The buyer can run the company in a commercially reasonable way without nullifying the metric. The seller’s transition role is clear, with incentives aligned to hit the targets. The total earn-out amount is meaningful but not so large that it dominates the deal.
If you read those lines and nod along, an earn-out likely helps. If you find yourself hedging on two or more, consider a different tool, such as a vendor take-back with covenants, a price adjustment mechanism, or an escrow tied to specific customer renewals.
Choosing the right metric: revenue, gross profit, or EBITDA
Metrics drive behaviour. In London Ontario deals we have structured, EBITDA-based earn-outs are the most frequent because they connect to real value creation after operating costs. But EBITDA can be gamed by shifting overhead or changing capitalization policies. Revenue is harder to manipulate and easier to understand, yet it ignores discounting and can spur unprofitable sales. Gross profit, or gross margin dollars, often hits the sweet spot in distribution, trades, and manufacturing where material costs fluctuate.
For subscription-like businesses, such as managed IT services, customer retention and net new monthly recurring revenue may be cleaner than pure revenue. In consumer businesses with one or two dominant accounts, it can be smarter to tie the earn-out to retention and growth of those accounts, provided everyone agrees on the baseline.
When we represent a seller, we push for a metric the buyer cannot choke through accounting decisions. When we represent a buyer, we ask to add quality guardrails such as minimum gross margin percentages or limits on non-recurring add-backs.
How long the earn-out should last
Most earn-outs we see around London run from 12 to 36 months. Under 12 months rarely proves anything. Over 36 months means you are dragging the deal too long and inviting disputes. A practical pattern is two measurement periods: year one and year two, with separate payouts to avoid arguments about whether a weak first year can be rescued by a strong second.
Seasonality matters. If the company does most of its work between April and August, make sure the period spans at least two peak seasons. And if a major customer has a fiscal year that drives buying decisions, sync the measurement period accordingly.
Setting floors, caps, and curves
Sellers prefer a gentle slope that pays something even if results fall a bit short. Buyers like hard thresholds, to avoid paying for mediocre outcomes. There is a middle ground. A tiered curve can pay zero under a minimum, then step up proportionally, and cap at a defined maximum to manage risk.
Here is a simple illustration from a local industrial services deal. Purchase price was 3.2 million at closing, plus up to 800,000 earn-out over two years tied to EBITDA:
- Year one: 200,000 payable at 900,000 EBITDA, scaling linearly to 400,000 if EBITDA hits 1.1 million, with zero below 850,000 and a cap at 400,000. Year two: 200,000 payable at 1.0 million EBITDA, scaling to 400,000 at 1.25 million, with zero below 900,000 and a cap at 400,000.
That structure recognized seasonality, set achievable floors, and offered upside without exposing the buyer to runaway payments.
Governance, reporting, and audit rights
Earn-outs invite disputes when definitions are vague. Good agreements spell out:
- The exact calculation method, including accounting standards, add-backs, and how to treat owner compensation post-close. Reporting timelines. Monthly management reports and quarterly financials are a reasonable minimum. Access to data. The seller should have visibility sufficient to validate the earn-out, not a fishing expedition into the buyer’s broader operations. Audit rights and a short, clear dispute resolution path. Agree on a neutral third-party accountant upfront, with specific time limits. Rules to prevent value shifting. If the buyer integrates the company, the agreement should protect against loading excessive shared costs or diverting revenue to affiliates.
A simple rule we use in London transactions: if two competent controllers cannot reproduce the same number from the same files within two hours, the metric definition is not ready.
Control, integration, and the seller’s role
Ask a hard question early: who will make the operating calls that affect the earn-out? Buyers should run the company in the ordinary course of business, but they also have a duty to protect their investment. If the seller remains in a leadership or consulting role during the earn-out, set a narrow scope with decision rights that support the metric. For example, give the seller a defined budget for sales hires or marketing campaigns tied to the growth plan. Limit distractions like major system overhauls until after the measurement periods unless both parties agree.
In one small business for sale London Ontario deal, the buyer wanted to roll the acquired marketing agency into their existing shop. The earn-out depended on EBITDA for the acquired entity. We set up a ring-fenced P&L for 18 months with agreed allocations for shared services, then planned the full integration after the earn-out sunset. The seller hit the targets, the buyer got a clean integration window, and disputes never materialized.
Tax and legal notes specific to Canada
We are not your tax advisors, so get tailored advice. That said, a few patterns show up repeatedly in Canadian transactions.
For sellers, the tax treatment of earn-out payments can be complex. In certain cases, when part of the sale price is contingent and cannot be reasonably determined at closing, Canada’s tax rules may allow the use of an earn-out method that spreads recognition of gain as amounts are received. This can reduce risk of paying tax on proceeds that never materialize. Documentation matters, and eligibility depends on factors like asset types and the nature of goodwill.
For buyers, deductibility depends on structure. If you are buying shares, earn-out payments usually form part of the share purchase price and are not deductible, but they increase the tax cost of the shares. In an asset deal, certain contingent payments tied to acquired assets may be added to the cost of those assets. Payments tied to employment or consulting services should be clearly separated, with appropriate withholding and payroll remittances if applicable.
On the legal side, make sure non-competition and non-solicitation clauses are appropriate for Ontario courts, both in scope and term, and that they are tied to protecting the goodwill you just bought. Reps and warranties should be consistent with the earn-out logic. If the earn-out assumes customer contracts transfer cleanly, ensure assignment and novation issues are handled at closing.
How financing interacts with earn-outs
Debt lenders care about predictability. Many banks in London will not underwrite senior debt on contingent consideration. They will underwrite the closing base price and may require covenants that indirectly limit aggressive earn-out schemes. If you are the buyer, clear your earn-out plan with your lender early so you are not surprised by covenant constraints on distributions.
If the seller is taking a vendor take-back note alongside the earn-out, decide priority. Most seller notes are subordinated to bank debt. Earn-out payments are often subordinated as well or at least conditioned on covenant compliance. Build a realistic cash flow model that includes the earliest and latest likely payment dates, not just a straight-line guess.
Real deal stories from our London files
A managed IT services firm with 2.1 million in annual recurring revenue had a churn problem in the prior year after a major client folded. The seller rebuilt with better clients on three-year contracts. The buyer proposed a valuation of 4.4 million based on current ARR but offered an extra 600,000 if net churn remained under 3 percent and ARR grew to 2.6 million within 18 months. The seller stayed on as a part-time advisor with a clear mandate to support cross-sell. Final outcome, the seller collected 520,000 of the 600,000, and both sides were content. The metric aligned well with value creation, and the time frame captured renewal cycles.
A specialty machine shop had a lumpy project backlog. The buyer and seller could not agree on EBITDA normalization due to a one-off pandemic subsidy and a large warranty claim. They used a two-year earn-out based on gross margin dollars with a hard floor on margin percentage to avoid buying unprofitable revenue. They also carved out warranty costs for legacy jobs to ensure fairness. That carve-out prevented finger-pointing and kept the earn-out focused on new work quality.
A third case involved a boutique retailer with strong online sales. The seller insisted on a premium tied to influencer-driven traffic. The buyer refused to measure social media metrics. They compromised with an earn-out tied to e-commerce gross profit plus first-order repeat rate within 120 days. That kept incentives on profitable growth, not vanity metrics.
Typical negotiation trade-offs
Negotiations tilt back and forth. Here are the themes we see repeatedly in businesses for sale London Ontario and around Southwestern Ontario.
- Sellers push for simple metrics and short terms. Buyers push for EBITDA, longer terms, and integration freedom. Sellers ask for audit rights and dispute timelines. Buyers ask for confidentiality and operational control. Sellers prefer curves that pay partial amounts below target. Buyers prefer cliffs to concentrate payment at success. Sellers want security, like escrow or a stand-by letter of credit. Buyers resist tying up cash, especially if also posting working capital. Sellers argue for protection from bad faith. Buyers ask for flexibility to defend margins in a downturn.
None of these are deal breakers. The art is matching metric, timeline, and governance with the real drivers of the target business.
A simple calculation example you can sanity check
Say you are buying a commercial cleaning company with 3.0 million trailing revenue and 360,000 EBITDA. You agree to pay 2.1 million at closing plus up to 450,000 over two years if EBITDA grows. You set the metric to EBITDA of the acquired entity, GAAP consistent with pre-close practices, plus agreed add-backs for owner comp above market, one-time legal fees, and integration costs capped at 25,000.
Targets:
- Year one: 400,000 EBITDA pays 150,000. 450,000 pays 225,000. Linear in between. Cap 225,000. Year two: 450,000 EBITDA pays 150,000. 525,000 pays 225,000. Linear in between. Cap 225,000.
If in year one EBITDA lands at 430,000, the earn-out pays 187,500. In year two, if it hits 470,000, payout is 175,000. Total 362,500. Now pressure-test the inputs. Does your staffing plan, price increases, and contract retention make those targets more likely https://www.scribd.com/document/1015602910/Business-Broker-London-Ontario-Choosing-the-Right-Partner-to-Sell-Your-Company-128948 than not? Would a 10 percent revenue shock break the model? Walk through the math with both sides present and agree on the spreadsheet, not just the legal language.
Avoiding disputes before they start
Most earn-out fights are born from ambiguity. They also happen when one side expects the other to behave in ways that were never written down.
Set definitions for revenue recognition, returns, bad debt, discounts, capitalization, and allocations to shared services. Define what reasonable efforts means for the buyer. If the seller expects the buyer to maintain a sales headcount or protect a marketing budget during the earn-out, specify the numbers. If the buyer expects the seller to be reachable for client introductions, set weekly time commitments and response times. Agree on what happens if a key supplier changes terms or a top client reduces volume.
We also recommend naming a tie-breaker accountant or mediator in the purchase agreement. It short-circuits escalation and keeps legal fees in check.
Where earn-outs intersect with off-market deals
Off-market opportunities can be terrific in London. We routinely meet owners who are not ready to go broad, but they will talk to one serious buyer. In these cases, data is often incomplete, especially around pipeline and normalized margins. Earn-outs can move an off-market business for sale to a successful close by adding a fair, time-limited test of the seller’s claims.
If you are the buyer, tread carefully. Off-market does not mean cut corners. Ask for monthly financials, customer concentration analysis, and supplier dependency notes. If the seller balks, use a short earn-out to bridge trust without deferring half the price to a hazy future.
Buyer and seller priorities at a glance
- Buyers care about clear definitions, integration flexibility, lender compliance, and not paying for revenue that cannibalizes other holdings. Sellers care about simple metrics, short terms, visibility into results, and confidence that the buyer will not starve the business during the measurement period.
Keep those priorities visible in the room. Deals move faster when both sides acknowledge the other’s non-negotiables.
How a local broker keeps the earn-out practical
A good business broker London Ontario sellers and buyers trust can help sort the signal from the noise. At Sunset Business Brokers, we take three roles in earn-out deals. First, we test the logic of the metric against the operating model. If targets require headcount that no one budgeted, we say so. Second, we translate accounting language into day-to-day routines, so the seller knows what reports will show and the buyer knows how they will be prepared. Third, we keep the deal team realistic about timelines and lender constraints.
We have also built a small library of local benchmarks, which saves time. For example, cleaning companies with year-round contracts in London typically run gross margins between 35 and 45 percent. Managed IT service providers with 15 to 40 small business clients often maintain monthly churn below 2 percent when contracts include vCIO touchpoints. These local anchors help set targets that are both stretching and fair.
If you are scanning for a small business for sale London or planning to list your own, you will hear from plenty of shops. You might even run into variations like liquid sunset business brokers in searches. Do your diligence. Work with business brokers London Ontario buyers and sellers have actually seen execute in your industry and at your deal size.
Practical steps if you are heading toward an earn-out
If you think your deal will include an earn-out, take a few actions before the heavy drafting starts:
- Clean up monthly financials for the past 24 months, including a clear chart of accounts and consistent revenue recognition. Build a simple driver-based forecast that connects hires, pricing, retention, and marketing spend to the earn-out metric. List proposed add-backs and non-recurring items with backup. Expect to negotiate each line. Decide the seller’s role and hours during the measurement period, and align compensation with the earn-out goals. Confirm lender expectations so the earn-out schedule fits covenant and cash flow realities.
Those five moves remove 80 percent of the friction we see in earn-out negotiations around buying a business in London.
A note on finding the right deals
Earn-outs are a tool, not a strategy. The bigger picture is finding the right business for sale in London Ontario and structuring a purchase that respects both sides’ risks. If you want to buy a business in London, your shortlist might include off market opportunities we cultivate quietly, as well as listed businesses where other buyers will compete. We maintain a live view of businesses for sale London Ontario owners are preparing, from service contractors and light manufacturing to e-commerce and professional services. If you are buying a business London or beyond Middlesex County, your preparation and your team matter as much as the inventory you see.
For sellers, the same applies. If your numbers are clean, your contracts transfer easily, and your growth plan is credible, you can often reduce the size or length of any earn-out. If you are earlier in the process, we help shape the story and the evidence so that when buyers arrive, they see value they can underwrite.
Final thoughts from the trenches
Earn-outs work best when they are simple, short, and aligned with how the business actually makes money. They break down when they try to solve too many problems at once, or when one side treats them like a magic fix for a weak base price. In London, where buyers are close to the work and sellers are often handing over something they built across decades, clarity and respect matter more than clever math.
If you are considering a business for sale in London, Ontario or preparing to sell, and you want a grounded view on whether an earn-out belongs in your deal, speak with a broker who has run the numbers and seen the movie. At Sunset Business Brokers, we are happy to pressure-test your targets, sketch a curve that fits your industry, and keep your deal moving to a clean close.