Holdbacks when selling a small business

Late in a sale, many buyers ask to keep back part of the price for a while after closing. To a seller that can feel like being told you are not trusted. It usually is not personal. A holdback is a common way to settle the buyer's worries about the unknown, and with a few clear terms it can be fair to you too. Here is how it works, in plain words.

The short answer

A holdback is part of the price that is paid later instead of on closing day. It sits with a neutral holder, usually a lawyer in trust, for an agreed period. If an agreed problem from before the sale comes up in that time, the buyer can be paid from it. When the period ends, the rest comes to you.

The terms that matter most are:

• How much is held back.
• How long it is held.
• What it can be used for, and how a claim is made.
• Who holds it and what releases it.

Why buyers ask for one

In the purchase agreement you make statements about the business, such as that the financial statements are accurate, taxes are paid and there are no lawsuits you know of. You also promise to cover the buyer if those statements prove untrue. A promise is only as good as the money behind it. Once you have been paid and moved on, the buyer worries they would have to chase you. A holdback keeps some of that money within reach.

Buyers also use holdbacks for specific worries, such as:

• bills or taxes from before closing that arrive later,
• a key customer, lease or licence that has not yet been confirmed,
• a closing working capital or inventory count that still needs final numbers,
• equipment that has to be repaired or replaced as promised.

Government clearances and holdbacks

Some government debts can follow a business to its new owner, so buyers and their lawyers check them before money changes hands. A few examples from public guidance:

• BC provincial sales tax. The Province says a buyer should have a PST clearance certificate before buying a business, or before buying substantially all of its goods in a bulk transaction. Without it, the buyer can be liable for PST the seller still owes.
• WorkSafeBC premiums. WorkSafeBC asks buyers to contact it before buying the assets of a firm, because unpaid premiums can lead to a lien on those assets. A clearance letter protects the buyer.
• Sellers who are not resident in Canada. Under section 116 of the Income Tax Act, if a non resident seller does not get a certificate of compliance from the CRA, the buyer may have to send part of the price to the CRA and can withhold it from the seller. Most sellers who live in Canada are not affected.

Other provinces have their own rules for sales tax and workplace insurance. Getting these clearances early, before closing, often means the buyer needs a smaller holdback, or none for those items. Ask your accountant which ones apply to your sale.

How a holdback compares with other ways of being paid later

• Holdback: money you have already agreed to receive, set aside to cover agreed claims, then released.
• Earn-out: extra money you only earn if the business hits targets after the sale.
• Vendor take-back: a loan from you to the buyer, paid back with interest over time.

An offer can include more than one of these. When you compare offers, add up what you receive on closing day, what is held back, and what depends on the future. The highest headline price is not always the best offer.

A simple worked example

These numbers are made up and rounded for illustration only. Your own deal will differ.

How to keep your holdback fair

• Tie the amount to real risks. Ask the buyer what exactly they are worried about. A named risk can often be fixed before closing instead, for example by getting a clearance letter or paying off a bill.
• Keep the period short and fixed. Agree a release date in the agreement, and consider releasing part of it at a halfway point if no claims have been made.
• Limit what it covers. Claims should be for agreed matters, made in writing with details and before the deadline.
• Use a neutral holder. A lawyer's trust account or an agreed escrow agent is safer for you than the buyer simply owing you the money.
• Settle interest and fees. Say who gets any interest and who pays any escrow fees.
• Agree how disputes are handled. If you disagree with a claim, only the disputed amount should stay held while you sort it out. The rest should still be released on time.
• Get it into the letter of intent. Raise the holdback in your letter of intent, so it does not appear as a surprise in the final draft.

How to lower the need for one

Buyers ask for bigger holdbacks when they feel unsure. Clean records, honest disclosure and a smooth due diligence process all lower that worry. Have your financial statements, tax filings, lease, key contracts and equipment list ready, and disclose known problems early. Our guide to documents needed to sell a business has a full list.

Questions to take to your lawyer

• What size and length of holdback is normal for a sale like mine?
• What exactly can the buyer claim against, and by when?
• Who holds the money, and what releases it?
• Which government clearances should I get before closing to shrink the holdback?
• How does the holdback fit with any limit on what I could owe after the sale?

For the wider picture, read negotiating the sale of your business and what your lawyer and accountant do. This guide is general information, not legal or tax advice for your situation.