Anonymised, illustrative composite. A manufacturing business sold on an earn-out that hit every metric — and a buyer whose acquisition credit agreement blocked the payment while a leverage covenant sat out of compliance.
At a glance
A light manufacturer was sold in an asset purchase for $3,800,000 cash at closing, with a revenue-based earn-out capable of paying up to $700,000 over two years. The buyer financed the acquisition with a senior secured credit facility from its bank, used partly to fund the cash portion of the purchase price and partly to refinance the buyer’s existing operations. Like most acquisition credit agreements, the facility contained a maintenance covenant requiring the buyer’s consolidated funded-debt-to-EBITDA ratio to stay at or below 3.5:1, tested quarterly, and a negative covenant restricting “Restricted Payments” — defined to include any earn-out or deferred purchase price payment — while a default or a covenant breach was continuing.
At the end of year one, the earn-out calculation confirmed the target had hit its revenue thresholds and $350,000 was earned and payable under the purchase agreement. But by that date, the buyer’s leverage ratio — driven by a downturn in the buyer’s pre-existing lines of business, unrelated to the acquired manufacturer, which was performing well — had risen to 3.9:1, above the facility’s 3.5:1 covenant. The buyer’s credit agreement flatly prohibited it from making the earn-out payment while that covenant breach was outstanding, regardless of whether the buyer had the cash on hand. The seller had a fully earned, fully calculated, fully undisputed $350,000 claim — and a buyer that was contractually forbidden by a third party from paying it.
No statute governs this; it is entirely a matter of what the purchase agreement said about the difference between an earn-out being earned and being payable. The purchase agreement, like most, treated the two as the same event: once the earn-out calculation was finalised and confirmed, payment was due within a fixed number of business days. It said nothing about what happened if a third-party financing document blocked payment. That gap decided the outcome, because the seller had no direct claim against the buyer’s lender — the seller was not a party to the credit agreement and had no ability to compel the bank to waive or subordinate its own covenant for the seller’s benefit — and the buyer, having contractually bound itself first to the bank, was in a genuine bind rather than acting in bad faith: it could not pay without triggering an event of default under its own senior facility, which would have been catastrophic for the whole business, including the acquired assets.
$350,000 earned and confirmed, against a buyer running at 3.9:1 leverage on a 3.5:1 covenant — a covenant breach entirely unconnected to the $3,800,000 acquisition or the manufacturer’s own performance, which was ahead of plan. The seller had no visibility into the buyer’s broader balance sheet at signing and no contractual right to any information about the buyer’s leverage position going forward.
The purchase agreement was silent on subordination or blockage, so the parties negotiated directly: the buyer agreed to pay interest on the deferred $350,000 at a stated rate for as long as its credit agreement blocked payment, with the principal due within 10 business days of the buyer’s leverage ratio returning to compliance or the facility being refinanced, whichever came first. The seller accepted deferral with interest because there was no clause forcing a faster outcome, and litigating a payment obligation the buyer was legally forbidden by its own lender from satisfying would not have produced a better result any faster.
A deferral-with-interest clause agreed at signing, rather than negotiated from scratch after the block arose, would have given the seller a defined interest rate and a hard outside date for payment regardless of the buyer’s financing position — instead of a negotiation conducted from a position where the seller’s only real leverage was the buyer’s reputational and relationship interest in resolving it fairly. Some sellers in this position also negotiate, at signing, a direct right to be notified of a leverage covenant breach and a most-favoured-treatment clause tying the earn-out to whatever terms the buyer’s other unsecured creditors get.
The tell was the asymmetry in what got negotiated: the earn-out metric, the accounting definitions, and the audit right were fought over hard, because they were visible and specific to this deal. The buyer’s own capital structure — the thing that actually determined whether an earned dollar could be paid — was never discussed, because it looked like the buyer’s business, not the seller’s deal. An earn-out is unmatured and contingent by nature, which is exactly why it tends to be subordinated by a payment blockage covenant rather than the standstill-on-enforcement mechanics that apply to a matured vendor take-back note.
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