Canada: Terms of the Deal: Both Price and Terms are Important

Business owners who are selling their company typically want to be paid the highest price. While this is certainly expected, they should be aware that the highest price may not reflect the best value for their company. This is because the terms of the deal are just as important as the stated purchase price. The terms of the deal dictate when, how and under what conditions the purchase price is (or is not) paid, and the tax consequences to the seller. Deal structuring can be complex, and appropriate legal and tax advice should be obtained.

Apart from cash at closing, deal terms often include holdbacks, promissory notes, share exchanges and earnouts. These alternatives are addressed in this newsletter. Business owners also have to consider whether to sell the shares or assets of their company – which can have income tax, legal and other consequences. It bears mentioning that different deal terms (commonly referred to as deal structuring) applies only to privately held businesses (or divisions / subsidiaries of public or private companies). Where a public company is acquired, securities legislation typically requires that the transaction be entirely financed with cash or the buyer's treasury shares at closing.


A buyer will insist on a holdback in virtually all transactions involving the purchase of a privately held company. Holdbacks protect the buyer against the risk that certain assets acquired at the closing date will not be realized (e.g. uncollectible accounts receivable) or that hidden liabilities exist. A holdback in the range of 5% to 15% of the purchase price, for a period of 6 months to 24 months is not unusual. The magnitude and length of the holdback depends on several factors, including:

  • The nature of the seller's business. Where the seller's company is exposed to significant risks such as major inventory write-offs or lawsuits, the holdback will generally be larger and longer;
  • Whether the seller's financial statements have been audited. If not, the buyer may perceive greater risk of hidden liabilities;
  • The representations and warranties agreed to. In particular, the buyer and seller typically establish "baskets and caps" (i.e. minimum and maximum amounts) for indemnifications. The amount and duration of a holdback often mirrors those provisions; and
  • Whether pre-existing liabilities exist. For example, if the seller's company is the defendant in a legal claim, a portion of the holdback may be "carved out" pending the outcome of that claim.

From the seller's perspective, a holdback is usually not a major issue, since the hidden liability or asset deficiency would have impacted the seller's in any event, had the business not been sold. However, the seller should insist that the holdback amount be placed in escrow, to reduce the collection risk once the holdback conditions have been satisfied.

In some cases the seller acquires representation and warranty insurance, so that the funds are immediately available for use. Representation and warranty insurance is only cost-beneficial in larger transactions, where the income that can be generated on the funds that would otherwise be in escrow exceeds the cost of the insurance policy.

Promissory Notes

Buyers sometimes use promissory notes where they do not have sufficient cash on hand, and cannot obtain debt financing on reasonable terms in order to consummate a transaction. Promissory notes are also used in cases where the buyer and seller have agreed to a longer-term holdback (e.g. where environmental issues exist).

Promissory notes are normally one to five years in length. In some cases, the buyer will issue redeemable preferred shares instead of notes. Promissory notes are usually unsecured or rank subordinate to senior lenders. Therefore, they pose a collection risk to the seller.

Sellers often look for a high interest rate in order to compensate them for the collection risk inherent in promissory notes. However, interest income is taxable to the seller at high tax rates. Therefore, a more advisable strategy may be to increase the purchase price and accept a low-interest (or no interest) rate promissory note. The higher purchase price is treated as a capital gain, of which only 50% is taxable.

Share Exchanges

Share exchanges involve the seller exchanging shares of their company for treasury shares of the buyer. Share exchanges are sometimes used by small-cap and mid-cap public companies that use their shares as currency in lieu of cash. Share exchanges with a buyer that is a privately-held company are unusual because of the challenges in establishing the value of the shares received, the uncertainty surrounding liquidity, and the complexities of negotiating a shareholder agreement.

A share exchange can be structured to defer taxes to the seller. The seller pays taxes once the shares that were received as consideration are sold. However, the seller should be aware of the risks they assume when accepting shares of a small-cap or mid-cap public company as payment. In many cases, there are restrictions on liquidating the shares received, often for a period of six to 12 months, depending on prevailing securities legislation. Even when no legal restrictions exist, there may be practical limitations on selling the shares where the buyer's stock is thinly traded.


Pursuant to an earnout, a portion of the purchase price is conditional upon the seller's company achieving agreed criteria after the closing date. There are five parameters to consider when negotiating an earnout:

  • The basis of measurement. Earnouts are typically expressed in terms of revenue or profitability (e.g. gross profit or operating income). Whatever basis is used, the rules for calculating it must be clearly defined;
  • The duration of the earnout. A period of one to five years is not uncommon. The longer the earnout, the less likely that it will be received;
  • The seller's ability to control the company's results following the transaction. In most cases, the seller will be employed pursuant to a management or consulting contract for the duration of the earnout period, so they can influence the likelihood that the earnout criteria will be achieved;
  • Whether or not the earnout is cumulative. That is, whether the seller has an opportunity to recover an earnout that was missed in one year by overachieving in a subsequent year; and
  • Minimum and maximum amounts. Most earnouts are structured as "cliff payments", meaning that no portion of the earnout is payable unless a minimum threshold is met (e.g. no earnout is payable unless the company achieves at least 90% of the agreed revenue target). Buyers typically insist that earnouts be capped at a maximum amount as well. Earnout limits are usually advisable from the seller's perspective as well, to ensure that the proceeds received are treated as a capital gain for income tax purposes (rather than ordinary income).

Final Thoughts

The terms of a deal are just as important as the stated purchase price. Sellers should recognize that any dollar not received at the closing date of a transaction represents a dollar at risk. They must be satisfied that the prospective reward is worth the risk. In some cases, it may be prudent to accept a lower cash purchase price than to deal with the risks and complexities of non-cash deal terms.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

In association with
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at and we will use commercially reasonable efforts to determine and correct the problem promptly.