An earn-out hands operating control to a buyer while leaving part of the seller's money dependent on how that control is used. The seller's only real protection is what gets written into the purchase agreement before closing — there is very little to fall back on after.
Key takeaways
The commercial logic of an earn-out is sound — it lets a buyer and seller close a deal despite disagreeing about the business's forward performance. The structural problem is that the buyer's post-closing decisions affect the metrics the payout depends on, and once the deal closes the seller has no operational authority to influence those decisions, only a contractual right to complain about them afterward. Every protection a seller negotiates is an attempt to close that gap in advance, because there is very little available to close it after the fact — the dispute-resolution routes that do exist are covered in dispute mechanisms for a contested earn-out payment.
The specific, drafted-in protections that do real work are covenants requiring the buyer to operate the business in good faith, in the ordinary course, or without taking actions specifically intended to reduce the earn-out payment. In practice this means naming the behaviours the seller is worried about rather than relying on a general good-faith standard: covenants preventing revenue reallocation to affiliates, requirements to maintain sales teams and marketing spend at pre-closing levels, and a requirement to maintain separate books for the acquired business so the metric stays measurable at all once it is folded into a larger operation.
A seller negotiating these covenants should treat each one as a direct response to a specific way the buyer could otherwise move the number without technically breaching anything — a general “operate in good faith” clause is a useful backstop but does very little work on its own against a buyer who genuinely believes a pricing change or a resource shift is good business, not bad faith.
Covenants over conduct are only useful if the seller can actually see whether they were honoured. Purchase agreements that protect a seller through an earn-out period typically pair the operating covenants with a defined reporting cadence — monthly or quarterly financial statements prepared on the same accounting basis used to calculate the earn-out itself — plus a right to review supporting records. Without that visibility, a seller only discovers a problem when the final number comes in short, by which point the covenant breach, if there was one, is much harder to isolate and prove.
The reporting right should specify a real audit mechanism, not just a right to receive statements: a right to have an independent accountant review the underlying books on reasonable notice, at a defined frequency, without needing to first prove a breach has occurred. A seller who can only demand records after already suspecting a problem is negotiating from a much weaker position than one with a standing right to look, which is why the strongest agreements build the review right in as routine rather than as an escalation step.
Where the seller retained a minority equity position rather than a pure cash-and-earn-out structure, CBCA s. 146(1) allows the shareholders to enter into a unanimous shareholder agreement restricting the directors' powers — giving the seller a contractual veto over specific decisions (pricing changes above a threshold, customer reassignment, discontinuing a product line) for the duration of the earn-out. That is a materially stronger protection than a covenant alone, because s. 146(3) makes it bind a later purchaser of the shares too, not just the original buyer. This only applies where the target is a CBCA corporation and where the seller actually holds shares to attach the agreement to — it is not available in a pure asset sale with no equity rollover.
Canadian law requires an earn-out discretion to be exercised honestly and in good faith, which is a genuine backstop against the worst conduct. But proving bad faith is far harder and far more expensive than drafting around it in the first place — which is the entire argument for the specific, named covenants above rather than relying on the general legal standard to do the work.
A seller of a commercial cleaning company agrees to a two-year, revenue-based earn-out and negotiates three specific covenants: the buyer must maintain the acquired company's pricing within 5% of pre-closing rates absent a documented cost justification, must not reassign named key accounts to another division, and must provide quarterly revenue statements broken out on the same basis as the pre-closing financials.
Fourteen months in, the buyer discontinues one of the acquired company's lower-margin service lines, citing group-wide standardization. Revenue on that line drops to zero, which measurably affects the earn-out calculation. Because the covenant only restricts pricing and account reassignment — not product-line decisions — the seller has no contractual basis to challenge the discontinuation itself, only an argument, harder to prove, that it was done specifically to reduce the earn-out payment.
The gap in this example is instructive: a covenant list that does not anticipate a specific category of decision leaves that category open, regardless of how good-faith the general standard sounds in the agreement's recitals.
It can be negotiated, and is more common where the seller retained meaningful equity. Absent an equity stake, a buyer is less likely to grant formal governance rights, though information and consultation rights over specific decisions remain negotiable even in a pure cash deal.
This is exactly what the separate-books covenant is meant to prevent. A seller should insist the acquired business's results be tracked discretely, on a defined accounting basis, for the full earn-out period — integration decisions that make that tracking impossible are themselves a common source of dispute.
Yes, as ordinary contractual obligations, and courts will also read in the good-faith requirement described above. Enforcement typically runs through the dispute-resolution mechanism set out in the agreement itself — see dispute mechanisms for a contested earn-out payment — rather than as a stand-alone claim.
Before. Agreeing to an earn-out in principle and leaving the operating covenants to be worked out in the definitive agreement gives up real leverage — a buyer who has already committed to the deferred-price structure has much less incentive to accept meaningful operating restrictions once the headline terms are settled. The covenant list is part of the earn-out negotiation, not a follow-on detail.
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