Most deals that close in London, whether you mean the UK capital or London, Ontario, close because buyer and seller find a way to bridge a valuation gap. Over the last decade, I have watched headline prices bend to market cycles, but two instruments show up again and again when real businesses change hands: earnouts and seller notes. Used well, they get deals done at sane prices and spread risk fairly. Used poorly, they harden into disputes, jam cash flow, and poison owner transitions that should have been smooth.
This is a practical guide to how these tools actually work on the ground. The context spans London’s finance and professional services density in the UK, and the pragmatic, credit-conscious mid-market in Southwestern Ontario. The dynamics differ, but the core mechanics travel across borders. If you are scanning for a small business for sale, comparing companies for sale in London, or narrowing in on a business for sale in London, Ontario, you will meet these concepts early. At Liquid Sunset Business Brokers, we spend as much time designing these structures as we do finding the right targets.
Why deals need bridges
Cash at close has become more expensive. In the UK, mainstream banks typically finance acquisitions of established, profitable companies when tangible security exists and serviceability is strong. In Canada, London Ontario buyers rely on a mix of senior debt from chartered banks or BDC, sometimes complemented by mezzanine providers. Across both markets, lenders are more conservative about forecasted synergies and pro forma adjustments than buyers or sellers. That leaves a gap between what sellers expect based on past or peak earnings and what lenders will reliably fund.
Earnouts and seller notes are the two most flexible planks across that gap. An earnout links part of the price to future performance. A seller note is debt from the seller that the buyer repays over time from the acquired company’s cash flow. They are often used together, with senior lenders insisting that the seller note sit behind bank debt in priority. Deciding how much to allocate to each depends on the quality of earnings, volatility, customer concentration, the buyer’s operating plan, and the seller’s appetite for risk after exit.
What an earnout actually is
Earnouts start simple in conversation and grow complicated in legal drafting. In its cleanest form, an earnout pays the seller extra if the business hits specific targets post close. The big decisions sit in four buckets.
First, the metric. In owner-managed businesses under three to five million of EBITDA, I prefer revenue-based earnouts only when margins are unusually stable. Otherwise, link to gross profit, EBITDA, or in recurring revenue businesses, net revenue retention and ARR. Metrics that are easy to audit reduce post close arguments.
Second, the measurement period. Shorter periods reduce uncertainty but also limit upside. I see 18 to 36 months most often. Anything longer risks fatigue and macro noise swamping the signal.
Third, the formula. A common approach pays a percentage of the amount by which the metric exceeds a defined threshold, up to a cap. Sliding scales reward exceptional outcomes without exposing the buyer to uncapped liabilities. Keep it simple enough that both sides can recalculate it on a spreadsheet without forensic accounting.
Fourth, control and operating covenants. Sellers worry that buyers will starve the business or change accounting policies to avoid paying. Buyers worry that sellers who stick around will push risky deals to hit targets. The solution is balance: covenant light enough for the buyer to run the company, but clear on prohibited actions that would artificially depress the metric, like diverting key accounts or changing revenue recognition.
Here is the shape I like. Define EBITDA using a schedule of add backs agreed by both sides, reference a pre close accounting policy memo, and state a hierarchy of principles that govern conflicts. Require reasonable efforts to run the business in the ordinary course. Allow capital investments if they are budgeted or bring clear paybacks beyond the earnout window. Let the buyer hire and fire. Prohibit bundling or transfer pricing with affiliates that distorts margins. Give the seller reasonable inspection rights, then channel disputes into an agreed independent accountant process with tight timelines.
The seller note in plain terms
A seller note is a loan from the seller to the buyer. The company’s cash funds repayment. From a buyer’s view, notes smooth cash outflows and signal seller confidence. From a seller’s view, notes keep skin in the game after exit and can be less volatile than an earnout.
Terms vary with risk and leverage. Across the deals I have worked on in London and London Ontario, rates spread from prime plus 2 to prime plus 6 in Canada, and from 6 to 12 percent fixed in the UK, depending on inflation and base rate environments. Interest-only periods of 6 to 18 months are common while integration settles, followed by amortization over 2 to 5 years. Security ranks behind the bank. Subordination and a standstill are almost always required so lenders do not get squeezed. If performance is uncertain, I sometimes add a payment-in-kind feature that lets interest accrue for a short window rather than trigger a default.
Covenants on seller notes should not mirror bank covenants. They need to be simpler and subordinate. Typical triggers include a payment default beyond a cure period, a bankruptcy event, or a prohibited transfer of collateral. Sellers often want accelerations tied to missed earnouts, but stacking those defaults can backfire if a single operational hiccup cascades into a liquidity crisis. Better to negotiate a cash sweep above a defined free cash flow threshold than to trip a hair trigger.
How earnouts and seller notes change the capital stack
Consider a £3.2 million enterprise value acquisition of a London UK B2B services firm with £700k EBITDA and low capex. A bank agrees to fund £1.6 million based on collateral and coverage, the buyer brings £800k equity, and the remaining £800k is split into a £400k seller note and a £400k earnout capped over two years. In a steady market, that is a strong, bankable structure. The note’s interest-only period aligns with integration, and the earnout shifts the debate about stretch valuation into a performance bet that both sides accept.
Now shift to London Ontario. A C$3.5 million price for an HVAC contractor generating C$800k SDE, converting to roughly C$600k EBITDA after professionalizing owner comp. Senior debt at C$1.8 million, buyer equity at C$900k, a C$500k seller note at prime plus 3 with a year interest-only, and a C$300k EBITDA-based earnout. Even conservative lenders can get behind that, because the seller shares some risk and the buyer is not draining working capital on day one.
Banks are typically allergic to earnouts that pay out too early or too richly. They want cash to de-risk their loan first. Write that reality into the term sheet. A payment waterfall might prioritize bank debt, then the seller note, then the earnout. Alternatively, the earnout can sit senior to the note but still subject to a minimum fixed charge coverage ratio. Either way, draft an intercreditor agreement that everyone reads and understands, not just the lawyers. When disputes come, and at some point they will, clarity beats cleverness.
Valuation theater and real money
Headlines dazzle. A seller hears eight times EBITDA from a friend in the pub and wants the same. In practice, that eight times might include a two times earnout that requires flawless retention and a growth spurt, plus a seller note that earns below market for its risk. The cash at close might be closer to five or six times. Buyers sometimes puff the multiple to win a process, then use diligence to retrade. Sellers resist and the deal sours.
The way out is to align on total consideration design early and present the blend honestly. When I run a sell side mandate at Liquid Sunset Business Brokers, I shape buyer expectations from the first call. If the buyer is searching for Liquid Sunset Business Brokers - buy a business in London or Liquid Sunset Business Brokers - buy a business in London Ontario, they will find us talking plainly about capital structures rather than dangling only the top number. That avoids surprises and compresses time to close.
Two deals, two cities, one toolkit
A London UK digital marketing agency with strong recurring retainers and a top-heavy client list came to market after the founders hit burnout. EBITDA was £1 million, but two clients made up 45 percent of revenue. We pushed toward an earnout to shift concentration risk. The buyer initially offered £6 million headline price with £4 million cash at close and a £2 million earnout based on revenue growth. The sellers preferred EBITDA because they expected to raise rates and trim unprofitable projects. We cut it this way: £3.8 million cash, a £600k seller note at 8 percent with 12 months interest-only then 36 months amortization, and a two year earnout that paid 40 percent of EBITDA above £900k, capped at £1.6 million. We locked accounting policies, set anti-avoidance language around redirecting clients, and gave the seller quarterly reporting. The bank signed off because cash obligations beyond bank debt were back ended and contingent. The sellers ended near their headline if they kept margins, and the buyer paid less if key accounts slipped.
In London Ontario, a specialty manufacturer with C$1.2 million EBITDA and a retiring owner needed an operator who could modernize the shop floor. The buyer had strong industry chops but limited cash. The seller wanted clean exit optics in the community but was pragmatic. We structured C$5.4 million total value as C$3 million senior debt, C$1.2 million equity, a C$900k seller note at prime plus 2 with a two year amortization after a six month interest-only window, and a one year, C$300k revenue-based earnout that paid 10 percent of sales above a conservative floor, capped at C$300k. Because margins fluctuated with input costs, revenue was simpler, and we drafted a pass through for extraordinary surcharges so the earnout did not punish defensive pricing. The note had a springing cash sweep if free cash flow exceeded a target, which made the seller comfortable with the shorter amortization. Closing took 91 days from LOI to funds flow, and the owner stayed on a part-time consultancy for six months.
The takeaway is not that one structure fits all. It is that the right combination reflects the company’s margin stability, customer concentration, capital needs, and the buyer’s plan.
The metrics that avoid heartbreak
Earnouts fail when the parties do not predict human behavior. If the seller needs to work in the business to hit targets, tie at least part of the earnout to inputs they can influence, like signed renewals of named accounts, not only outputs like overall EBITDA. If the buyer plans a rebrand, acquisitions, or shared services, be explicit about how that will be allocated. The best drafts anticipate future gray areas.
In retailers and restaurants, same store sales and contribution margin beat topline revenue that can be bought with discounting. In software, gross margin matters more than vanity ARR if upsells require heavy professional services. In project-based businesses, trailing twelve month metrics averaged quarterly smooth volatility and reduce incentives to push revenue across period ends.
Seller notes get into trouble when amortization schedules ignore seasonality. I watched a UK distributor default in month eight because payments peaked https://eduardoxmnw282.cavandoragh.org/how-sunset-business-brokers-finds-hidden-businesses-for-sale-in-london as inventory built for Christmas. We reprofiled with lighter spring payments and heavier autumn ones. That small tweak would have saved months of stress if we had modeled cash cycles earlier.
How banks and private lenders see your terms
Senior lenders like predictability. Before they consent to a seller note, they test fixed charge coverage with conservative assumptions. They want the power to block discretionary distributions that threaten repayment, and they prefer earnout triggers that are not front loaded. Paper your deal so they have visibility into operating performance and the ability to step in if covenants spin out. Extraordinary items need a clear definition and a cap on add backs. If your deal depends on vendor rebates, contract renewals, or a handful of major customers, build sensitivity cases where one or two fall away.
Private credit funds, when they play in this size range, charge more and ask for stricter covenants, but they can be nimbler. They may even accept an earnout that pays earlier, provided the seller note is tiny or absent. Buyers who want speed sometimes choose this route to beat competitors in processes for an off market business for sale.
Earnouts and culture after close
Mechanics aside, earnouts affect how people behave. If the seller stays on, they count days and milestones. If they exit entirely, they still watch the numbers. The buyer’s managers may resent the shadow of past owners shaping decisions. The healthiest dynamic is transparency. Publish the earnout calculation method in the management pack. Communicate when you miss a month and why. If you must make a strategic move that hurts the earnout but wins long term, put it on the table and, if necessary, negotiate an adjustment.
One tactic that helps is a small management bonus pool aligned with the earnout. If the team feels skin in the game, they work toward the same finish line. It also reduces the perception that the seller is the only one benefiting from short termism.
UK and Canada, tax and practicalities
Tax treatment can influence preferences. In the UK, earnout payments structured as part of the sale consideration can qualify for capital gains treatment if drafted carefully, though complex rules apply when the earnout is satisfied in loan notes or shares. Sellers should get advice early to avoid income tax treatment on contingent payments. In Canada, vendor take-back notes are common, and interest is taxed as income. Earnouts are more complex and can be taxed differently depending on how they are structured, when they crystallize, and whether they are ascertainable at the time of sale. Both jurisdictions reward early planning and clear drafting. Neither rewards assumptions made at midnight before signing.
On the regulatory and banking practice front, the UK often uses debentures over company assets and personal guarantees in smaller deals. In Canada, general security agreements and specific security over equipment or receivables are standard, again with personal guarantees where businesses are tightly held. These realities shape how much seller security is even possible. A seller note may be unsecured in substance, even if on paper it lists collateral, because the bank sits ahead. That should inform rate, term, and reserve judgments.
Where to find deals suited to these structures
Small business for sale London searches usually surface brokers who know the local lending and legal landscape. If you are chasing Liquid Sunset Business Brokers - off market business for sale or Liquid Sunset Business Brokers - business for sale in London Ontario, you are likely reacting to the scarcity of clean listings that fit lower middle market criteria. Off market outreach works when you are patient, transparent about structure, and armed with lender feedback. Many owners have never heard the terms earnout or vendor take-back, yet they grasp the logic in a five minute walk through. Show them examples, not jargon.
For London UK, professional services, tech-enabled services, specialty construction, and healthcare support businesses commonly blend seller notes and earnouts because working capital is manageable and customer contracts provide visibility. For London Ontario, manufacturing, trades, logistics, and multi-location services like fitness and pet care see similar blends, with local banks often keen if the buyer brings sector know-how. A business broker London Ontario team that understands bank appetites can save months of trial and error.
It helps to be discoverable. I see buyers and sellers arrive via search phrases like Liquid Sunset Business Brokers - liquid sunset business brokers, Liquid Sunset Business Brokers - sunset business brokers, or Liquid Sunset Business Brokers - businesses for sale London Ontario. Spelling and punctuation vary, intent does not. People want a guide who can steer structure as deftly as they source targets.
Red flags and how to disarm them
Some patterns repeat.
Sellers who want a rich earnout but no reporting later. That is an argument waiting to happen. Insist on agreed templates and access, then narrow the scope so it does not disrupt operations.
Buyers who propose a large earnout on a metric they fully control and plan to change. If you will centralize purchasing, rebrand, or alter pricing, be explicit about how that hits the formula. If necessary, add a collar that adjusts thresholds when major policy changes occur.
Seller notes with aggressive amortization that collide with growth investments. If you need to hire a sales team or add a production line, negotiate a lighter first year schedule or a cash flow sweep instead of fixed heavy principal.
Overlapping defaults where a missed bank covenant automatically accelerates the seller note and cancels the earnout. Layering penalties compounds risk and can flip bargaining power in a way neither side intended.
Earnouts that expire right before the business reaps the benefit of early investments. Align periods with the realistic payback of your plan.
When to prefer an earnout over a seller note, and the reverse
- Choose an earnout when headline expectations outrun bankable performance, and the seller remains involved or the business has stable, auditable metrics. Choose a seller note when cash flow is steady but the buyer needs time to build liquidity for full payment, and when banks require seller alignment without contingent complexity. Blend both when the business has concentration or volatility that deserves performance risk sharing, but the buyer also needs a predictable debt service profile. Avoid an earnout if you plan major strategic shifts that will cloud measurement, or if accounting systems are weak and hard to trust. Avoid a seller note if the company will be thinly capitalized post close and lenders prohibit meaningful junior debt service in the early months.
A field-tested checklist for drafting
- Lock accounting policies in a schedule, with examples, not just definitions. Set an independent accountant dispute mechanism with short timelines and cost sharing. Build a pro forma 36 month cash flow model that includes all debt service, earnout ranges, and working capital seasonality. Align intercreditor agreements early so banks, sellers, and buyers know the waterfall and cure rights. Tie management incentives to the same targets to harmonize behavior.
Putting it together without drama
There is craft in getting from LOI to a signed set of documents that reflect business reality. Lead with a one page term summary that maps the earnout metric, period, cap, and example math, plus seller note rate, term, amortization, security, and subordination. Do not hide softer points like audit rights and anti-avoidance language. Share it with your lender before the lawyers fire up their templates. Ask them blunt questions about prohibited payments and required cushions. Bring your accountant into the calculation examples, then have them pressure test the company’s ability to produce the data. A two hour pre mortem between buyer and seller where you list ways the earnout could fail, then patch those holes in drafting, is worth a week of emails later.
From my side of the table at Liquid Sunset Business Brokers, the best outcomes happen when both parties leave a little on the field. The seller accepts that some of their upside depends on events after they hand over the keys. The buyer recognizes that inherited goodwill has value that deserves respect and, in some cases, contingent payment. The structure then expresses that respect in numbers and timelines.
Whether you are scanning Liquid Sunset Business Brokers - small business for sale London, Liquid Sunset Business Brokers - business for sale in London, Liquid Sunset Business Brokers - buy a business London Ontario, or Liquid Sunset Business Brokers - buying a business in London, your search will lead you back to these same, durable tools. They are not shortcuts. They are honest ways to deal with the messiness of risk and the reality of cash. Done right, they turn a handshake into a closing call, and a closing call into a stable first year that gives both sides what they wanted in the first place.